A bridge loan is a short-term loan that is taken to meet an urgent financial requirement, with long-term financing still in the pipeline.
A bridge loan, which is otherwise known as a bridging loan, caveat loan, or swing loan, is a short-term financing for the borrower, who has already applied for a long-term financing. The loan period may vary with different vendors, but it can range between twelve months to three years. Sometimes, these loans are approved for a few weeks too. One of the main features of this loan is the high rate of interest attached to it. A bridge loan may also have other fees and costs, but the positive side is that the finance is arranged within a very short time, with comparatively less documentation. Some people resort to this type of finance to benefit from the short-term loan, and also as a short-cut for a long-term finance.
- As stated earlier, these loans are usually associated with high rates of interest, that too for a very short term. Usually, the rate of interest of a bridge loan ranges from 12% to 15% for a term of about 12 months to three years. The lenders may charge an additional 2 to 4 points, as compared to long-term loans.
- A bridge loan can be of two types – open and closed. A closed type has a predetermined time period and a well-defined repayment source for paying back the loan, whereas an open one does not need any such prerequisites.
- This type of loan is often associated with higher loan-to-value (LTV) ratios. The LTV ratio is derived by dividing the mortgage amount with the least selling price or appraised value. Usually, this ratio in bridge loan does not exceed 65% for commercial properties, and 85% for residential properties.
- The LTV ratio for a first charge bridging loan is higher than that of a second charge bridging loan (a first charge bridging loan will replace any outstanding mortgage and will have a first legal charge on your property and a second charge bridging loan will have a second charge on your property alongside your existing mortgage). Even though the first charge bridging loans on residential property are for a shorter period of time, it is also regulated by the FSA.
Bridge Loan and Real Estate Industry
This loan is very much useful in case of immediate financial requirement. In real estate industry, this loan is mainly used for immediate purchase of a property offered at a cheap rate, or for retrieving a property from legal proceedings initiated by a creditor for a loan that is in default.
Builders or developers also resort to bridge loans, in case of projects pending for approval. Without approval, there is no guarantee for any progress of the project and it is not entitled to get loans from the conventional sources. Hence, the developer opts for a bridge loan, which may be attached with a high rate of interest. Once the project is approved, it is entitled for long-term loans from the conventional sources. Generally, such long-term loans are for a bigger amount and with a low interest rate. This amount can be used for repayment of the bridge loan and the completion of the project.
Apart from real estate investment, bridge loans are used in venture capital and corporate finance. Offering bridge loans is like gambling, as there is no guarantee of repayment. Hence, very few banks offer such loans. However, in some cases, these loans are secured with collateral, like real property. These loans are equally risky for the borrower, as they are associated with many terms and conditions regarding the interest rates, fees, and penalties. It is really very important to go through the clauses carefully, and to search for any other means of raising funds, before accepting a bridge loan.
Disclaimer: The information provided in this article is solely for educating the reader. It is not intended to be a substitute for the advice of a professional.