A bridge can be defined as a means of connection or transition. In terms of financing, a bridge loan is a short-term loan for a person or a business to either secure more permanent financing or pay off an obligation. Essentially, a bridge loan covers a gap when financing is needed but not available. They are not a long-term financing solution.
Bridge loans are granted for less than one year and carry a higher interest rate. The loan can be secured by real estate or inventory as collateral. They can be structured in different ways. Some require monthly payments of either interest-only or principal plus interest. In contrast, others may require a lump-sum payment at the end of the term. There may be closing costs, including origination fees and appraisal.
Both individuals and businesses utilize bridge loans. Here are two examples of how they can be used:
If a person buys a new house intending to sell their current home, a bridge loan can finance the new property. The old property is the collateral for the loan. Once it sells, the proceeds from the sale pay off the bridge loan, and a traditional mortgage then finances the new property.
The advantage of using a bridge loan in this scenario is that the buyer will not have to make a contingency offer to the seller of the new house. It makes it a more appealing deal if there are multiple offers on the table. It is also more convenient for the buyer since they do not have to sell their current home, find temporary housing, and move again into the new house.
A business may be doing a round of equity financing, or selling shares, to finance operations. The money from selling those shares may not be realized for several months. The business owner can use a bridge loan to cover operating costs such as payroll, utilities, inventory costs, and other expenses until the round of equity financing closes.
Bridge loans can be faster to access but trickier to qualify for, so they are not a solution for everyone. Typically, the borrower should have decent equity to qualify. Alternatives to a bridge loan are home equity lines of credit, personal loans, and second mortgages. Work with a trusted lender to discuss market conditions and pencil out numbers. You will have peace of mind with a plan to meet the repayment obligation.