What Is a Bridge Loan?
A bridge loan is a short-term loan used until a person or company secures permanent financing or removes an existing obligation. It allows the user to meet current obligations by providing immediate cash flow. Bridge loans are short term, up to one year, have relatively high interest rates and are usually backed by some form of collateral, such as real estate or inventory.
How a Bridge Loan Works
Bridge loans, also known as interim financing, gap financing or swing loans, bridge the gap during times when financing is needed but not yet available. Both corporations and individuals use bridge loans, and lenders can customize these loans for many different situations.
[Important: Bridge loans provide immediate cash flow, but come with high interest rates and usually require collateral.]
How Do Businesses Use Bridge Loans?
Businesses turn to bridge loans when they are waiting for long-term financing and need money to cover expenses in the interim. For example, imagine a company is doing a round of equity financing expected to close in six months. It may opt to use a bridge loan to provide working capital to cover its payroll, rent, utilities, inventory costs and other expenses until the round of funding goes through.
How Do Buyers of Real Estate Use Bridge Loans?
Although rare, bridge loans sometimes pop up in the real estate industry. If a buyer has a lag between the purchase of one property and the sale of another property, they may turn to a bridge loan. Typically, lenders only offer real estate bridge loans to borrowers with excellent credit ratings and low debt-to-income ratios. Bridge loans roll the mortgages of two houses together, giving the buyer flexibility as he waits for his old house to sell. However, in most cases lenders only offer real estate bridge loans worth 80% of the combined value of the two properties, meaning the borrower must have significant home equity in the original property or ample cash savings on hand.
Bridge Loans vs. Traditional Loans
Bridge loans typically have a faster application, approval and funding process than traditional loans. However, in exchange for the convenience, these loans tend to have relatively short terms, high interest rates and large origination fees. Generally, borrowers accept these terms because they require fast, convenient access to funds. They are willing to pay high interest rates because they know the loan is short term and plan to pay it off with low-interest, long-term financing quickly. Additionally, most bridge loans do not have repayment penalties.
Example of a Bridge Loan
When Olayan America Corporation wanted to purchase the Sony Building in 2016, it took out a bridge loan from ING Capital. The short-term loan was approved very quickly, allowing Olayan to seal the deal on the Sony Building with dispatch. The loan helped to cover part of the cost of purchasing the building until Olayan America secured more-permanent, long-term funding.