What is A Bridge Loan?

what is a bridge loan
September 12, 2020

Bridge loans are widely used in business and real estate because they allow borrowers to take advantage of opportunities as they arise without waiting to get approved for traditional loans that may take a long time to process.

What is a Bridge Loan?

A bridge loan is essentially a short-term loan [as per wiki] —usually lasting anywhere from six months to a year—used until the borrower can secure more-permanent financing. It can be the right financial solution if you need immediate cash to meet current obligations. A bridge loan is backed by collateral, such as inventory or real estate. Because they are risky for the lender, they carry relatively high-interest rates compared to other credit solutions such as home equity lines of credit.

Bridge loans are known by many names – including swing loans, gap financing, and interim financing. It can be applied by individuals and corporations. Lenders can customize the terms of these loans to suit different requirements and situations.

For example, a homeowner can use gap financing to purchase a new house while waiting for their current home to sell. This allows them to immediately snap a good deal and ensure that the new place doesn’t go to another buyer.

In commercial real estate or CRE, many investors use bridge loans to rehab or take advantage of buying opportunities until long-term financing can be arranged.

An example of a bridge loan used in commercial real estate –

In 2016, Olayan America Corporation used a bridge loan from ING Capital to buy the Sony Building. ING approved a short-term loan very quickly, thereby letting Olayan secure the deal on the building before others could move in. The loan was used to cover a portion of the cost of buying the property until Olayan secured a more permanent and long-term funding solution.

Bridge Loans v/s Traditional Loans

Bridge loans offer the benefit of a faster application and approval compared to traditional loans. This convenience does come at a price, though. When you take out a bridge loan, expect to pay more in interest fees and origination fees. Terms are also shorter. That said, bridge loans can certainly be beneficial for borrowers who need quick access to cash and eventually intend to pay off the loan with long-term, low-interest financing.

What is a Bridge Loan Used for?

Bridge Loans used in Business

Many businesses—even the most well-established brands—regularly turn to bridge loans to access immediate cash to cover costs in the interim, while they wait for long-term financing. For example, a company might be trying to raise equity financing and expects investments within six months. It can use a bridge loan to finance its payroll, utilities, rent, inventory expenses, and other costs until funding goes through.

Bridge Loans Used in Residential Real Estate

These types of short-term loans are also widely used in the residential property industry. Many buyers turn to bridge loans to cover the lag between purchasing a property and selling another to finance it. Think of a bridge loan as rolling the mortgages of two properties together, providing buyers flexibility while waiting for their old home to sell. Do note that in most cases, only 80% of the two properties’ combined value is offered by lenders; the borrower needs to have either ample cash on hand or significant equity in the original property.

What is the Use of Bridge Loans in Commercial Real Estate?

In CRE, swing financing is mostly used to bridge the gap between present and future circumstances. Commercial real estate investors use it until they can arrange more-permanent funding, such as a mortgage. Bridge loans are also called hard money loans in this industry. They can be handy in some situations, as discussed below.

Commercial real estate bridge loans have terms of anywhere from a few months to a year, though in some cases, the terms can last more than a year. Being collateralized loans, they require you to put up the commercial property you will shortly purchase or already own.

Unlike in traditional loans, the creditworthiness of a borrower doesn’t matter much here. What lenders look at is the value of the collateral—in this case, the commercial property. This is why CRE Bridge loans are generally easier to get compared to a standard mortgage. Proceeds from the loan can be used on a property you want to buy or already own.

Below are some examples of bridge loans used in commercial real estate:

Moving to a new commercial/industrial location

You can use a bridge loan if you intend to move to a new venue, such as a new warehouse, office, or storefront. In this case, proceeds from the loan can be applied to the down payment on the new property or pay off the remaining loan on the old property.

Let’s illustrate this example further. Let’s say you wish to buy an under-occupied office structure for $10,000,000 and spend another $10,000,000 to renovate it and make it more attractive to new tenants. The property should be worth around $25,000,000 after renovations, according to expert appraisers. A CRE bridge loan provider agrees to let you borrow 80% of the $20,000,00 (the sum of $10,000,000 to purchase it and another $10,000,000 to renovate it), amounting to $16,000,000.

This means you need to provide the remaining $4,000,000. After completion of the project, you may be able to obtain a $25,000,000 mortgage on the property and use the bulk of the proceeds to completely pay off the bridge loan (both interest and principal). With the interest rate being 10%, your cost for the one-year swing loan will include prepayment penalties, origination fees, and other such costs.

Taking advantage of a buying opportunity

Do you want to snap up a great deal on a commercial property before your competition can get their hands on it? A bridge loan might come in handy in this case, helping you make the down payment as well as the monthly payments on the property while you wait for long-term financing with more affordable rates.

Rehabilitating a commercial property

Do you currently own a commercial property that could be doing better? Perhaps it’s not performing to its fullest potential? You can use a hard money loan for extensive renovations to increase the occupancy rate and ultimately the property’s income. The hard money loan can pay for the remedial work; you can replace it with long-term financing once the property has been renovated.

Borrow money when you have a low credit score

If your commercial real estate investment business has a less than stellar credit score, it can be tough to get approved traditional financing. Luckily, you may be able to qualify for hard money loans. And if you’re able to make timely payments on your bridge loan, you might improve your credit score and eventually become eligible for traditional financing.

How to Get Approved for Commercial Bridge Loans

In general, bridge loan providers are more concerned about the value of the commercial property serving as collateral than on the borrower’s credit score. Do note that hard money loans are often capped at 70% to 80% to limit their financial exposure. This means that you need to be prepared with your equity. It’s also worth noting that some lenders look at other factors such as the property’s condition and location and if it carries any liens. Some lenders may also consider the borrower’s circumstances. They look for red flags such as major derogatory events, foreclosures, lawsuits, bankruptcies, felonies, and garnishments.

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