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What is a Bridge Loan?
A bridge loan is a type of short-term loan which is used by an individual or company as they secure permanent financing or deal with an existing obligation. It provides immediate cash flow to allow short term obligations to be met. These loans have high interest rates and usually, go up to one year since they are short term. They are backed up by collateral such as inventory or real estate.
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How Does a Bridge Loan Work?
These loans are used to bridge the gap when there is a need for financing, and it's not yet available. They are also known as swing loans, gap financing or interim financing. These loans can be customized to meet the requirement of different situations. Both businesses and individuals use them. Businesses utilize these loans when they need to cover the current expenses as they wait for long-term financing. For example, a company may decide to use a bridge loan to cover the interim expenses if it is conducting a round of equity financing that is expected to complete in about six months. The current expenses to be covered include, utilities, rent, and payroll, among many others. Sometimes bridge loans are used in the real estate industry. A buyer who may be having a lag in the purchase of one property and the sale of another may decide to use a bridge loan. However, these real estate bridge loans are only to borrowers who have good credit ratings and also low debt-to-income ratios. The bridge loans provide flexibility to a buyer who is awaiting the sale of his old house, by rolling together the mortgages of the two homes. The lenders mostly provide bridge loans which are worth 80% of the combined value of the two properties. So a borrower in need of financing must then have significant home equity in the property or considerable cash savings. When compared to traditional loans, bridge loans have a faster application, approval and funding process. They also have higher interest rates and large origination fees. The reason why most borrowers accept these terms is that they need fast and convenient access to funds. Most of them plan to pay off this loan quickly using low-interest, long-term financing. Most of these loans lack repayment penalties.