The Ultimate Guide to Understanding Bridge Loans

Bridge Loan Explained- Types, Pros & Cons, and How to Get

We know the traditional and most followed way of applying for a loan. But how often do we prefer such loans that require a long period for approval and granting, whose payments are subject to interest rates and other applicable fees? Only sometimes. Right? To cut the disadvantages of regular loans, Bridge loans offer all other alternatives not available with regular loans.

What is a Bridge Loan in simple terms? 

Bridge Loans, in all respects, solve the financing problem until you secure a long-term loan. If you think Bridge loans can replace other loans, that's mistaken, as they are specifically built to fix short-term financial problems. Bridge loans are typically paid back in 1 to 3 years, making them a unique financing option. 

Bridge loans are like temporary loans that help carry out short-term financial needs. They offer immediate cash flow to meet the current obligation. Generally, businesses or individuals in immediate need of cash and waiting for approval choose a Bridge loan. Mostly, homebuyers opt for Bridge loans as they borrow money against their current home to make a down payment on a new one. 

Gists: 

  1. Bridge loans have a duration of 6 months to a year. They require a collateral.
  2. Interest rates are slightly higher than regular loans.
  3. Bridge loans are also known as Bridge financing, bridge loan, interim financing, gap financing, and swing loan. 
  4. The process of applying for and getting approval for a bridge loan is faster than traditional loans, and hence, it is considered the most significant advantage of a Bridge loan.

How do Bridge loans work? 

As the name implies, Bridge loans are made to bridge the gap until you can access other financing options. They are the unique tools offered to a borrower that have different structures, costs, and conditions. 

If you look at the most common example, when a homeowner buys a new house and sells its current house, it becomes quite challenging to coordinate with both transactions. Only when the first home is sold will the homeowner face difficulty making a downpayment if sufficient cash is unavailable. To overcome this difficulty, the buyer takes a bridge loan to cover the down payment. 

Due to their unique characteristics, some traditional lenders only make bridge loans available; online lenders commonly bestow them for the short term. Due to their easier availability and the fast lending process, they are more expensive than traditional ones.

What are the different types of bridge financing?

Bridge loans effectively manage short-term needs when you urgently need some money. You can go for it depending on various purposes.

1. Bridge Financing for Debt: 

  • If you face a problem while paying a debt, which is temporary, you can go for bridge loans as they can provide you financial relief from the problem. 
  • However, bridge loans come with high interest rates, and they can eventually widen the problem in the long run. 

2. Bridge Financing for IPO:

  • The initial IPO process requires plenty of money to get started. It also includes a flotation cost for underwriting, investment bank fees, and legal and accounting services. For many businesses, it becomes a necessity to Bridge loans to incur the cost. 
  • Therefore, Bridge financing is used by many businesses to take a bridge loan before initiating an IPO.

3. Closed Bridge Financing: 

  • When you and the lender oblige and agree to the agreed-upon terms, then it's closed bridge financing. In a closed financing agreement, the terms and conditions are pre-decided. The agreement ensures the borrower repays the loan amount per the fixed duration. 
  • Closed Bridge financing provides clarity and shapes the loan repayment process.

4. Open Bridge Financing: 

  • When the loan servicing period is not fixed or pre-determined, such loans are open bridge financing. It also means they must specify the loan terms and are subject to uncertainty and challenges in timely repayments.
  • Such loans do not guarantee the timely servicing of loans. 

5. First and Second Charge Bridge Financing:

  • These types of bridge financing help to determine the right on the collateral in case of failure of any payment by the borrower.
  • First Charge Bridge financing: It implies the first claim on collateral by the lender in case the borrower fails to repay the loan. 
  • Second Charge Bridge financing implies the second claim on the collateral after any other lender who holds the first charge. 

How long are bridging loans for?

  1. Bridge loans are short-term financing options that save you until you secure long-term financing or pay off existing debt. They last a short period, usually around six months to a year. 
  2. If a borrower's credit profile is impressive enough to the lender, he can grant a bridge loan for 2 to 5 years.

Who offers Bridge Loans?

Many lenders in the USA offer Bridge loans, like Private debt funds, traditional banks, or government agency lenders. 

Here are a few names of lenders that grant bridge loans:

  1. PNC Banks
  2. Bloomfield Capital
  3. Socotra Capital
  4. Arbor
  5. Avana Capital

Are bridge loans hard to get?

To get approval for a Bridge loan, the borrower must qualify. However, the qualification process depends on the type of bridge loan, but a specific compulsion is collateral.

Bridge loans can be more difficult to get than traditional loans because

  1. They are short-term financing options with higher interest rates and require less time for repayment.
  2. Applicants must have a strong credit score, financial history, and, most importantly, collateral to secure the loan.
  3. Getting approval for a bridge loan is more difficult during uncertain markets.

Bridge loans are considered an expensive alternative that helps to meet funding needs. 

Despite having bad credit, you can still be approved for a bridge loan due to its collateral requirement. However, you get a loan for higher interest rates or specific repayment terms.

What is the interest rate on a bridge loan? 

Bridge loans are high-risk sub; therefore, they have higher interest rates and fees. 

A typical bridge loan includes interest rates ranging from 6% to 12%, originating fees of 1% to 2%, and appraisal fees from $500-$1,000. It also takes in the legal fees, escrow fees and prepayment penalties. 

  1. Interest rate: Depends on the borrower's creditworthiness and overall risk associated with the loan. 
  2. Origination fees: Charged as a percentage of the loan amount, typically cover the administrative cost of the lender. (Negotiable)
  3. Appraisal fees: These are based on the appraisal report's property type, location, and complexity.

What are the advantages & disadvantages of bridge loans?

Bridge loans advantages

Despite being an expensive option for many, a Bridge loan is more than a financing tool for some. Due to its various advantages, many borrowers willingly pay high interest rates.

1. Flexible and can be shaped according to the needs

They are flexible, which means they can be shaped according to specific investment needs. Bridge loans are made for various purposes, such as purchasing or refinancing residential properties, commercial properties, vacant land for investment, etc. They bridge the gap and offer liquidity while you wait for long-term financing.

2. Bridge loans don't need hefty documentation.

As collateral is a primary requirement for Bridge loan approval, many lenders skip the documentation process like tax returns. They only need financial strength, creditworthiness, and real estate experience to lend for higher loan amounts and favorable interest rates.

3. A viable option for multi-million-dollar investment

They are more suitable for high-value investments like luxury properties, pre-construction condos, and land for development. This makes it a viable option for multi-million-dollar investment. 

4. Bridge loans are a quick cash-in-hand option.

Bridge loans are good for those borrowers who urgently need a big amount. As lenders close the process within a week or two, it's a good quick cash-in-hand option.

Bridge Loan Disadvantages

1. Bridge loans are expensive financing tools.

Bridge loans are higher-interest loans when compared to traditional mortgage loans. Borrowers also pay debt service on the bridge loans with their current mortgage. In addition, the borrower also pays appraisal fees, administration fees, Escrow fees, loan orientation fees, and notary fees. This makes it an expensive financing tool. 

2. Bridge loans may align with some real estate financing.

Although Bridge loans are suitable for real estate financing, they may only work for some real estate projects. This is because some lenders only favor lending against completed properties or current assessed value. If someone needs a loan against a property that needs renovation or some fixation, they might receive a smaller loan amount. 

3. Bridge loan lenders demand equity.

Apart from paying massive interest on bridge loans, some borrowers even give the lender some equity in their property. Many lenders ask for at least 20% equity. This becomes more challenging for people to pay higher interest and equity at the same time.

Suggested Articles:

  1. Business Loans vs Personal Loans
  2. How to get loan for small business
26 Nov, 2023

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