Bridge loans are a type of short-term loan pending the arrangement of larger or longer-term financing.
It is usually called a bridging loan in the United Kingdom, also known as a caveat loan, and also known in some applications as a swing loan. In South African usage, the term bridging finance is more common, but is used in a more restricted sense than is common elsewhere.
A bridge loan is a short-term loan used until a company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short term with relatively high interest rates and are usually backed by some form of collateral such as real estate or inventory.
Also known as interim financing, gap financing or swing loans, bridge loans “bridge the gap” during times when financing is needed but is not yet available. Both corporations and individuals use bridge loans, and lenders can customize these loans for many different situations.
How Do Businesses Use Bridge Loans?
Businesses turn to bridge loans when they are waiting for long-term financing and need money to cover expenses in the interim. For example, imagine a company is doing a round of equity financing expected to close in six months. It may opt to use a bridge loan to provide working capital to cover its payroll, rent, utilities, inventory costs and other expenses until the round of funding goes through.
- Bridge loans are used in venture capital and other corporate finance for several purposes:
- To inject small amounts of cash to carry a company so that it does not run out of cash between successive major private equity financings.
- To carry distressed companies while searching for an acquirer or larger investor (in which case the lender often obtains a substantial equity position in connection with the loan).
- As a final debt financing to carry the company through the immediate period before an initial public offering or an acquisition.
How Do Bridge Loans Work in Real Estate?
Although rare, bridge loans sometimes pop up in the real estate industry. If a buyer has a lag between the purchase of one property and the sale of another property, he may turn to a bridge loan. Typically, lenders only offer real estate bridge loans to borrowers with excellent credit ratings and low debt-to-income ratios. Bridge loans roll the mortgages of two houses together, giving the buyer flexibility as he waits for his old house to sell. However, in most cases, lenders only offer real estate bridge loans worth 80% of the combined value of the two properties, meaning the borrower must have significant home equity in the original property or ample cash savings on hand.
What Are the Differences Between Bridge Loans and Traditional Loans?
Bridge loans typically have a faster application, approval and funding process than traditional loans. However, in exchange for the convenience, these loans tend to have relatively short terms, high interest rates and large origination fees. Generally, borrowers accept these terms because they require fast, convenient access to funds. They are willing to pay high interest rates because they know the loan is short term and plan to pay it off with low-interest, long-term financing quickly. Additionally, most bridge loans do not have repayment penalties.
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