What is a Bridge Loan?
Bridge Loan Definition
A bridge loan (also known as gap financing or a swing loan) is a short-term loan for the purpose of “bridging a gap” and providing immediate cash flow to take advantage of an opportunity or meet some obligation.
Generally, terms are only one year or less and have high-interest rates with some sort of collateral to back them such as real estate or inventory (Investopedia).
More commonly used for business purposes, individuals may also find utility for them. As for business usage, if a company has applied for a long-term loan, but the process is expected to take longer than what is needed, a bridge loan will be approved quickly and can cover expenses until the real funding is in place.
Commercial bridge loans
Bridge loans are more common in the commercial space, used for a variety of purposes, from a quick source of working capital while waiting for a loan or source of funding to come through, or large purchases that may be a limited-time opportunity.
Other particular circumstances that may benefit from a bridge loan:
- To continue smooth operations so a partner of a business can take over while the other partner leaves.
- To carry a company right before an IPO or acquisition.
- To aid a distressed company while looking for investors or buyers.
Some experts claim that, while bridge loans are not the best option in all circumstances, as the housing markets continue to grow, they become more viable, especially for an individual building a home or for a business as a short-term mortgage for property development.
In 2017 most of us heard about Amazon.com buying Whole Foods grocery store chain, the 4th largest US retail deal in history thus far. The bridge loan used to cover the purchase was $13.7 billion with a term of 364 days.
Residential Bridge Loans
When purchasing or building a new home (especially if building) most individuals will want their new home secured and ready to move in to before selling their current home. A bridge loan can be a short-term option to roll both mortgages together and provide flexibility for the buyer. The loan is secured by the current home, but keep in mind many of these loans will only cover 80% so having enough equity or cash savings is a must.
While best determined on a case-by-case basis, a bridge loan isn’t always the best option. Some lenders require the homeowner to be qualified to own two homes which is a pretty stringent requirement. On top of that, making two mortgage payments while accruing loan interest at a rapid pace, albeit for the short term, can be very stressful for an individual.