What is Bridge Loan?
Bridge Loans represent a source of short-term financing until the borrower – either a person or corporation – secures long-term financing or removes the credit facility altogether.
How Does a Bridge Loan Work (Step-by-Step)
Bridge loans, or “swing loans,” function as short-term, temporary financing provided with the intention to last around six months and up to one year.
Short-term bridge financing loans are most common in the following areas:
- Real Estate Transactions: Finance the purchase of a new home prior to selling the current residence.
- Corporate Finance: Fund M&A deals where more financing commitments are needed for the deal to close.
In either scenario, the bridge loan is designed to provide near-term funding during a transitionary period.
The bridge loan closes the gap between the date of the new purchase (i.e. transaction close) and the date when permanent financing has been found.
Bridge Loan in Real Estate Financing: Mortgage Example
Under the context of real estate, bridge loans are utilized when the buyer has insufficient funds to purchase the new property without first selling the property still in their possession – i.e. that is currently on the market.
Typically, these types of short-term instruments are characterized by the following characteristics:
- Secured with Current Home Pledged as Collateral
- 6-Month to 1-Year Lending Term
- Same Lender is Often Financing New Mortgage
- Borrowing Ceiling of ~80% of Original Home’s Value
In effect, the temporary financing commitment offers homebuyers the opportunity to purchase a new house prior to actually selling their current home.
Pros of Bridge Loans: Speed, Flexibility and Closure
- Quick, Convenient Source of Financing
- Increased Flexibility (i.e. Bypass Hurdles with Further Delays)
- Removed Contingencies and Doubt from Other Parties (e.g. Seller)
- Could Directly Result in a Successful Deal
Cons of Bridge Loans: Interest Rates, Risks and Fees
- Expensive Fees (i.e. Upfront Charges, Higher Interest Rates)
- Risk of Losing Collateral
- Origination Fees (i.e. “Commitment Fees”)
- Short-Term Financing with Penalties (e.g. Funding Fees and Drawn Fees to Incentivize Repayment)
- Approval Required Strong Credit History and Stable Financial Performance