Definition of a Bridge Loan – Simply stated, a short term loan (12 months) to acquire and rehab an investment property until you sell (exit) or refinance to conventional or rental loan product with a longer term.
What Is a Bridge Loan?
A bridge loan is interim financing used by either an individual or a company for a period of time until they can secure permanent financing. These loans are short-term in nature.
A company that will be doing a round of equity financing in the near future might turn to a bridge loan in the interim to ensure they have sufficient cash to meet short-term operating needs for things like payroll, purchases, etc.
Individuals might need a bridge loan in connection with a real estate transaction. An example might be if you want to purchase a new home, but your old home has not yet sold. The bridge loan helps borrower “bridge” the gap between the time their old house sells and provide cash to buy the new home.
Bridge loans generally require collateral and carry relatively high interest rates.
What Are the Pros and Cons of a Bridge Loan?
- A bridge loan can be a good source of temporary funds to get them through a financing gap, such as the period before they go through a new round of equity financing.
- Funding can be quick with certain lenders.
- Some commercial bridge loans may have prepayment incentives that can save the company money if they are able to pay off the loan early.
- Commercial bridge loans can be expensive both in terms of the interest rate plus fees such as origination fees and others that the lender might tack on.
- Even though these loans are short-term in nature, if the business hits a tough financial patch or the business deal falls through, the company can be stuck with additional high-cost debt on its balance sheet that it will need to refinance.
- A bridge loan can offer interim financing for individuals who are looking to buy a new home while still waiting for their existing residence to sell.
- Based on the structure of the payments, the borrower might be in line for a few months of free payments.
- This allows the home buyer to go ahead and purchase a new home without a contingency that they are first able to sell their old one.
- Bridge loans are generally an expensive way to borrow.
- The borrower must be able to qualify for this additional debt and must have acceptable collateral.
- They are still dealing with interest and payments on two loans, this can cause financial stress.
- If their old home doesn’t sell, or if the economy suddenly tanks, they could find themselves saddled with more debt than they can handle.