Bridge Loans Provide Fast Cash for Investors in Need of Funding

Investors, whether individuals or businesses, occasionally need temporary financing for a real estate purchase or other large investment. Those seeking short-term financing like this may apply for a bridge loan or bridge financing from a lender.

What Is a Bridge Loan?
A bridge loan is also called gap financing or interim financing. Often utilized when a person or company expects to sell or refinance an asset quickly, bridge loans allow them to continue moving forward while awaiting long-term financing for one reason or another. Individuals or organizations seek bridge loans for a variety of purposes, such as funding a project while awaiting permit approval, avoiding foreclosure, or closing on a property quickly.

Compared to a traditional loan, a bridge loan goes through a faster approval process and can be applied to finances far more quickly. However, it also includes higher interest rates and shorter terms. The loans also demand collateral, such as a real estate property or another type of high-value asset. Borrowers accept the terms of these loans because they need the convenience of fast financing and expect it to be a short-term solution that they can pay off once they receive more permanent financing in the near future.

How Does a Bridge Loan Work?
In order to obtain bridge financing, individuals or companies often use the equity of an existing asset as a down payment when buying a new asset or property. The lender they work with develops a loan that will work best for the investor, based on the type of asset or property they own or plan to purchase. However, a bridge loan often comes with a higher interest rate than other types of financing.

Lenders agree to bridge loans with terms between six and 60 months and prefer to fund borrowers with high credit scores. Oftentimes, a lender will work with the borrower to refinance the loan through a more long-term loan. Generally, interim finance agreements do not impose repayment penalties, given that these types of loans are meant to be paid off in full in a brief amount of time. Lenders expect to close the loans within a matter of months.

How Are Bridge Loans Used in Business?
Bridge loans serve a range of purposes in business. For instance, in real estate, someone looking to acquire a new property while selling another can use bridge financing to combine two mortgages into a single loan until the original property sells. This method benefits a property owner facing foreclosure. It may also attract investors looking to close on a property within a limited time frame.

Real estate most commonly uses bridge loans, but other industries seek interim financing as well. As an example, business or construction investments may be funded through bridge loans while awaiting permit approvals or other compliance or agreement milestones. If a deal requires financing up front, before permitting can be attained, a business may choose to source capital through interim financing. That way, it can cover operational costs, such as payroll and utilities, until long-term financing becomes available.

The appeal of a bridge loan is its promise of quick cash flow during a gap period when an individual or company expects to be cash strapped. However, these borrowers need to secure long-term financing within no more than a few years in order to make good on the terms of the loan.

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Construction Loans Simplified

Lenders issue construction loans for the creation of new buildiings. These may be residential properties, such as single-family homes, or commercial properties, such as shopping centers, office buildings, warehouses, hotels, and industrial facilities. The funds cover building costs, including raw materials, labor, and equipment leasing or purchasing.

Private lenders usually offer construction loans on a unique schedule. Instead of disbursing loans as lump sums to borrowers, lenders disburse them in tranches as the building project goes through various stages.

A typical building project has five core stages: base-down, frame-up, lock-up, fixing, and completion. At each of these stages, private lenders release a portion of the loan to cover related expenses.

At the base-down stage, lenders release financing to cover the building of the foundation. At the frame-up stage, funds cover raising the structure and exterior framing. At the lock-up stage, money covers the brickwork. At the fixing stage, financing covers the internal work, such as building internal walls and installing kitchen and bathroom fixtures. Finally, at the completion stage, funding covers wall and ceiling finishes and electrical appliances. This layered model ensures that builders have enough money for every stage of construction, minimizing the risk of funds running out before completion.

Building on their one-of-a-kind loan issuance model, construction loan lenders schedule unique repayment terms for borrowers. During the building process, borrowers pay interest-only payments on the amounts they withdraw. When the building is complete, borrowers pay a lump sum for the entire amount they received plus interest.

In some cases, private lenders waive interest payment during the building process, but this does not mean that the interest is forgiven - it accrues and is added onto the principal. In the end, when the building is complete, the borrower must pay a higher lump sum.

In practice, however, property developers do not pay these lump sums after completion. Instead, they refinance the loans into permanent mortgage-type loans and pay the principal plus interest payments monthly for 15 to 30 years. Therefore, borrowers must apply again for a traditional loan when their property is finished. This is called multiple close financing.

Reacting to the needs of their borrowers, many private construction lenders offer the option of borrowing two loans as a single package - a construction loan and a permanent loan. The construction loan covers development, while the permanent loan converts or modifies the first loan into a traditional mortgage. This all-in-one loan is known as single-close financing.

Single-close financing has many benefits. The first is convenience. Borrowers apply once for a construction loan and receive two loans in one package. The package also offers more security for construction projects. Since the rates are locked early in the project, a borrower can budget easily for the future.

Multiple-close financing, on the other hand, is preferred by borrowers who want flexibility. While this method requires them to apply for two different loans, they can shop around for loans with lower interest rates. They do not have to settle for the limited offerings of one lender.

This flexibility, however, comes at the expense of security. Should the borrower’s financial capabilities or the economic environment change during construction, the borrower may find difficulty in securing a second loan or getting it at a low rate.