What Is a Bridge Loan?
In an ideal setting, an investor can use the funds from the sale of one property to pay for the purchase of a second one. There might come a time when the gap between sales is large enough that an investor can't immediately use the proceeds from the sale of Property A to cover the cost of purchasing Property B. In that case, they need funding to "bridge" the gap. Enter bridge lending, also called bridge funding, bridge financing or a bridge loan.
People can use bridge loans when they are buying and selling properties for personal use. A business or professional investor can also use a bridge fund to cover a gap in funding.
What Is a Commercial Bridge Loan?
What is a bridge loan, and how does it work? A commercial bridge loan provides an investor with a way to pay for a new investment before selling an existing one. The loan is a stopgap. Once an investor gets more permanent financing, such as a commercial mortgage, they pay off the balance on the bridge loan. Technically, any loan used to finance a short-term purchase is a bridge loan. A company that wants to purchase a large stock of inventory during a liquidation sale can use a bridge loan to afford the purchase. An investor might also use a bridge loan to buy a property that needs to sell quickly.
Several features set commercial bridge loans apart from other loan types.
- Loan term: Many commercial mortgages have terms from five to 20 years. The term of a bridge loan is much shorter, often less than one year. Some might have repayment due in full after just a few months.
- Interest rate: The interest rate on a bridge loan is usually higher than the rate on a commercial mortgage or another type of business loan. Some bridge loans are amortizing, meaning the borrower can pay less interest if they pay the loan down ahead of schedule. Others have a factor rate, meaning the borrower will owe the same amount of interest if they pay quickly or pay on a set schedule.
- Speed of funding: It can take weeks to get a conventional commercial mortgage or business loan. Bridge loans have a shorter turnaround time, meaning an investor can get one quickly to pay for an immediate opportunity.
- Collateral: Usually, a bridge loan requires collateral, such as real estate.
- Source of funding: Funding for a bridge loan can come from various sources, including traditional banks, private lenders, hard-money lenders and accredited investors.
How Do Bridge Loans Work?
A bridge loan can provide a real estate investor or company with cash to use temporarily until a more permanent source of financing comes through. With bridge financing, companies or individuals can invest in more real estate, buying more properties than they could if they relied on more traditional forms of financing. A bridge loan gives an investor extra time to shop around for a suitable mortgage, instead of feeling compelled to accept the first commercial mortgage they qualify for.
Several factors determine the amount a person or company can borrow as a bridge loan and the fees and interest they pay. Usually, a bridge loan won't be for more than 80% of the property's value. Interest rates can range from the low single digits to mid-double digits. For borrowers, some fees commonly associated with bridge loans include an appraisal fee and origination fee.
Usually, payment on a bridge loan is due in full by the end of the term. Some loan programs offer borrowers the opportunity to extend the loan term if needed. For example, a borrower with a six-month bridge loan might not successfully line up a commercial mortgage by the end of the six months. They can request an extension, meaning it will take longer for the investors to recoup their investment and earnings.
While collateral and higher interest rates offer private investors some level of protection should a borrower default on a bridge loan, it's also a good idea for investors to do their due diligence before deciding to lend money.
What Are the Benefits of a Bridge Loan?
Bridge loans benefit investors who offer the loan and borrowers who apply for and receive them. Some advantages of bridge loans include the following.
- Diversity: Bridge loans let investors diversify their portfolios. In addition to investing in stocks, real estate and bonds, bridge loans open another income stream.
- Short turnaround: Bridge loans are ideal when a borrower needs cash ASAP. The loans are well-suited to helping borrowers who might be struggling with cash flow and who need a boost to get them through until a second loan gets approved or until they make a significant sale. Since bridge loans often have a short term, lasting less than one year, investors who participate in bridge funding programs can expect to see a return on their investment sooner rather than later.
- Opportunities for real estate investors: Obtaining a bridge loan means a real estate investor can take advantage of opportunities they would otherwise have to pass over. For example, a borrower can use the funding to buy one property that becomes available while they are selling another, without using a contingency clause or waiting for the first property's sale to go through.
- Usually a higher rate of return: Due to the funding's shorter term and urgent nature, bridge loans typically have higher interest rates than traditional commercial mortgages.
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