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What is a Bridge Loan?
Mary McMahon
Mary McMahon
A bridge loan is a form of short-term financing which extends a line of credit to a borrower for a short period of time, typically at a very high rate of interest. As the name suggests, a bridge loan bridges the gap between more permanent methods of financing; these loans are sometimes used in the real estate industry, by venture capitalists, and by some investors. This type of loan is not available at all banks, since it tends to be more risky than long-term lending options.
The advantage of a bridge loan is that it provides an immediate flow of capital, which can be extremely useful. For example, a real estate speculator might get a bridge loan in order to buy a piece of property which is being offered at an extremely good price, with the intention of getting a loan with better terms later. Bridge loans are also used to make up various other temporary funding shortfalls. Someone might also use a bridge loan for something like purchasing a used car, with the intent of repaying the loan over several months.
The length of a bridge loan varies widely; some are as short as two weeks, while others last up to three years. Typically, the borrower must offer up something like real estate or business inventory as collateral for the bridge loan, and he or she may also have to pay a high loan origination fee on top of the interest and other fees which may be associated with the loan.
Bridge financing can be risky for the lending bank, since the lender may not always be able to repay the loan. It is usually only offered by larger banks which can afford delinquency, or banks which gamble on high-yield, high-risk investments. For borrowers, these loans are a double-edged sword, especially when the borrower does not take the time to carefully review the terms of the loan; penalties for delinquency can get very costly, very fast, for example. This problem is especially common with new borrowers; when considering any loan, it is always a good idea to read the fine print.
You may also hear a bridge loan referred to as a swing loan or swing financing. People who are offered such financing may want to carefully consider the offer, and see if they have other means of raising the needed funds. A home equity loan, for example, may come with a lower interest rate.
Mary McMahon
Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a WiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.
Learn more...
Mary McMahon
Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a WiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.
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Discussion Comments
@David09 - I believe there are other alternatives to bridge loan financing. I have a friend who did something similar except he couldn’t get a bridge loan; however, his bank did offer him a home equity line of credit and he was able to use that for down payment.
The disadvantage was that he had to start paying down the loan right away, even while his house was on the market. In his case it took six months for the house to sell and from what he tells me, he had to do a lot of belt tightening to swing those payments in addition to his mortgage.
But he came out clean in the end. Regardless of whether you do a bridge loan or a line of credit, this is definitely not for the faint of heart.
@NathanG - It was an equity bridge loan, our house was paid off and we had excellent credit. Banks will take chances from time to time but you have to have all your ducks in a row. In the end the house sold in three weeks and we paid off the loan a month later at closing.
By that time, we had carried the loan for four months since we didn’t put the old house on the market right away, and that’s where the $2,000 came in. I think it was $500 per month in interest.
It’s steep and risky, but if you’re creditworthy, they’ll take a chance.
@David09 - I’m surprised you had no problem getting a residential bridge loan. My understanding was that banks were leery of giving out these bridge loans in the aftermath of the mortgage meltdown.
I was told that banks everywhere was insisting on 20% down payment. A realtor friend of mine told that the only exception to the rule was in commercial bridge loans, where someone was buying property to build a business.
In that case I suppose the existing business served as somewhat of collateral. How did you manage to get the bridge loan?
We took out a bridge home loan when we bought our new house. The reason we did it was that we didn’t have enough money in savings for the down payment.
However, the old house was completely paid off. So we used the equity in the old house to secure the bridge loan.
We basically borrowed against the old house. That is certainly risky but it worked in our case. We were given a bridge loan that represented the amount of equity in the old house, so we brought nothing of our own money to closing.
We paid something like 7% interest on the bridge loan. When we finally sold our old house it came out to $2,000 total that we paid out of our sale, so that’s where we took the hit.
However, the old house sold within a matter of weeks so it was worth it.
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