Bridge loans are a type of loan a person or entity uses until they can secure permanent financing or pay an existing obligation. These funds generally provide cash while the borrower works to secure long-term funding. Individual borrowers and companies might be interested in obtaining bridge loans if they experience a gap in financing for an investment expense or covering existing obligations.
While utilizing bridge loans can be a successful tool for borrowers to finance an investment during an interim period, making bridge loans may also benefit investors. Being a lender on a bridge loan may be a good way to diversify your portfolio and increase profitability. With several types of bridge loans available and dedicated funds that specialize in making bridge loans, determining whether to invest in bridge funding requires thorough research and evaluation of the business or individual’s financial goals.
The 1031 Crowdfunding Bridge Financing Fund
At 1031 Crowdfunding, we offer a bridge financing fund for individuals or entities to capitalize real estate properties. The bridge financing fund is an investment in a limited partnership that makes bridge loans for real estate that will ultimately be used for Delaware Statutory Trusts (DST).
Accredited investors who invest in our bridge fund offering earn income from quarterly interest payments generated from the investment. As other investors purchase DST shares, the loan’s principal returns to the bridge fund, so it can be used for loans to future DSTs.
For further discussion of the risks and benefits of this offering, please visit the fund’s FAQs section.
What Is a Bridge Loan?
Because bridge loans provide immediate cash, these loans often carry higher interest rates than traditional loans. The borrower often backs these loans with collateral like real estate properties, business inventory, or other assets. Lenders of bridge loans earn income from interest payments and a return on their principal at the end of the loan term.
In an ideal setting, a property owner or real estate 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: the bridge loan.
Bridge loans are useful when an individual or business requires immediate financing and is reasonably sure they will quickly receive additional funding from a stable source. Securing a bridge loan can have a relatively short turnaround time, meaning a borrower can get one quickly to pay for an immediate opportunity. People can use bridge loans when they are buying and selling properties for personal use. A business can also borrow a bridge loan to buy investment properties or cover a gap in funding.
Bridge loans can offer relatively reliable protection to lenders if the borrower secures the bridge funds against their collateral, such as real estate. However, as with all investments, there is no assurance that lenders will receive a return on their financing. Bridge loans also carry a higher degree of risk to the borrower because of the stiff penalties if they default. Depending on the loan terms and collateral coverage ratio, borrowers could lose their assets at a ratio of 2-to-1 or 3-to-1.
It is in the borrower’s best interest to repay a bridge loan as quickly as possible. Therefore, companies and individuals should apply for bridge loans when they are confident they can repay the loan within the desired time. The best times to apply for bridge funding depends on the company or individual’s goals, though many choose to obtain financing when a larger flow of funds is expected to arrive before the loan term ends.
For example, an individual can use a bridge loan to buy a new home before selling the old one. Once the old house sells, they can use the incoming funds from the sale of the old property to pay the bridge loan.
Types of Bridge Loans
Financial institutions, individual private lenders, and other lenders offer several kinds of bridge loans depending on the applicant’s situation. Individuals interested in obtaining a bridge loan should understand the differences between the types available to select the one that best fits their needs:
1. Debt Bridge Financing
Some businesses might decide to acquire debt when comparing different kinds of loans. Debt bridge financing provides companies with immediate financing until they secure a permanent loan. These sources of funding are short-term.
The bridge loan interest rate starts at the prime rate and changes according to the borrower’s creditworthiness and debt-to-income (DTI) ratio. Typically, lenders only offer bridge loans to borrowers with excellent credit and low DTI ratios.
Bridge loans usually come with higher interest rates compared with other types of loans. This high interest rate is a significant factor to consider when determining whether debt bridge financing is suitable for a business. In some instances, interest rates are so high that further financial struggles can arise, so borrowers seeking bridge loans need to be careful.
Companies typically have to apply through their current financial institution to secure bridge loan financing.
2. Equity Bridge Financing
Sometimes, a business may need immediate cash to stock inventory or expand in some other way but wants to avoid taking out a high interest loan. Equity bridge financing offers the lenders equity in the business instead of taking out bridge loans and promising to pay them back with interest.
In exchange for providing immediate financing to the business, the lenders receive an equity stake in the company. Lenders will generally only agree to this arrangement if the business seems likely to become profitable. The business might approach a venture capital firm rather than a bank to obtain this kind of financing.
3. IPO Bridge Financing
An initial public offering (IPO) is the process through which businesses initially sell company shares to the public through the stock exchange. IPOs can be successful ways to raise capital, but the process can be expensive and drain a private company’s funds. IPO bridge financing provides funds to complete this process.
During the IPO process, companies must pay for expenses like stock exchange and underwriting fees. Companies that receive IPO bridge loans pay the loans off immediately after the IPO process using cash from the sale of shares.
Investment banks provide many IPO bridge loans, and companies offer the lender discounted shares to help offset the loan. Although these loans are also considered short-term, the IPO process could take several months or up to a year.
4. Commercial Bridge Loans
A commercial bridge loan allows businesses to pay for a new investment property before selling an existing one. Often, the borrower uses the property they are buying as collateral for the commercial bridge loan, though they may also use business inventory or similar assets.
Several features set commercial bridge loans apart from other loan types. For example, the interest rate on a bridge loan is usually higher than the rate on a commercial mortgage or another type of business loan. Some commercial 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.
Businesses may be able to obtain a commercial bridge loan from a bank, alternative lender, or hard-money lender.
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 for which they qualify.
Several factors determine the amount a person or company can borrow as a bridge loan and the fees and interest they pay. If the loan is for a property rather than other forms of collateral or assets, the loan usually 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 appraisal and origination fees.
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 lenders who offer the loan and borrowers who apply for and receive them. Borrowers can benefit from the following advantages of bridge loans:
- Interim financing: The most significant benefit for borrowers is that they can gain interim funding for short periods, often before taking out a more long-term loan.
- Short turnaround: Bridge loans are an excellent solution when a borrower needs cash immediately. These loans can help borrowers who might have an unsteady cash flow and need a financial boost until a bank approves a second, long-term loan or they complete a significant sale. Bridge loans often extend over a short period, usually less than one year.
- Opportunities for real estate investment: Borrowers who secure bridge funds and loans can take advantage of additional investment opportunities they would miss without the funds. For instance, real estate investors can borrow a bridge loan to buy a property that becomes available while selling another. This eliminates the need for a contingency clause and allows the borrower to purchase the available property before the first property’s sale goes through.
Individual private lenders can also gain benefits from investing in bridge funds, such as:
- Diversity: Individuals can invest in bridge loan funds to diversify their portfolios. In addition to investing in stocks, real estate, and bonds, bridge loans open another income stream.
- Short loan terms: Because of this short loan life, investors participating in bridge funding programs can expect a return on their investment sooner than with other loans. Short-term loans are also less impacted by duration risk, which measures an investment’s sensitivity to fluctuating interest rates. Since most bridge loans are for up to a year, their interest rates are less likely to rise significantly over the loan’s duration.
- 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.
Bridge Funding Examples
Companies and people might need bridge loans in various situations. At any point when a business or individual needs a short-term supply of funds to complete an expansion, make a purchase, or simply operate during a period with limited financing, a bridge loan could be an effective solution.
In a corporate example, company XYZ will complete a large sale in six months. The company must still pay operating costs before they receive the money from the sale. A possible solution is obtaining bridge loans to cover the waiting period.
Individual investors can use bridge loans when they are between real estate purchases. Suppose a real estate investor is waiting to sell an apartment complex and finds a deal for an industrial manufacturing building. In that case, they might not have the funds to purchase the industrial property unless they sell their other property. A bridge loan provides the necessary cash to purchase the second property while the apartment complex sale finalizes.
Register to View All Properties — Learn More About Investing With 1031 Crowdfunding
1031 Crowdfunding offers a marketplace of fully vetted real estate offerings and a bridge financing fund. Our bridge financing fund allows investors to benefit from diversification and predictable interest rates. Check out some of our previous deals, then register as an investor to see what properties we currently have available and gain access to the 1031 Crowdfunding Bridge Fund.
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