What is a bridge loan?

Bridge Loan is the loan used by a company or an individual when any other form of financing is not available at times of urgent requirements. It is a short term based loan employed by the borrower until the borrower becomes financially stable and is able to fulfil all the financial obligations. 

Due to the short term nature and associated risk factors, bridge loans have high interest rates. Hence it also requires a collateral, which may include business inventory or real estate assets. Bridge loans are mostly used in sectors such as real estate and corporate finance. They are also known as interim financing or bridge financing.

See also: Collateral in home loans

 

Types of Bridge Loan

There are four primary types of Bridge Loans as follow:

• Open Bridging Loan
• Closed Bridging Loan
• First Charge Bridging Loan
• Second Charge Bridging Loan

Open bridging loan

In this kind of bridge loan the payoff date is not predetermined and hence is mostly used by borrowers with uncertainty of  when the permanent finance will be available.

Closed bridging loan

This kind of bridge loans have lower rate of interest as the timeframe of loan repayment is agreed by both the parties. Hence it is in favour of the borrower.

First charge bridging loan

It is a short-term financing secured by a first legal charge on the loan money. This means that in the event of default, the lender has the first claim on the loan amount.

Second charge bridging loan

It is a short-term loan secured by a second legal charge on the loan amount. In the event of default, the second charge lender follows in line for claiming the loan amount after the first charge lender. Second charge loans are considered riskier, so they often come with higher interest rates compared to first charge loans.

 

How does a Bridge Loan work?

Bridge Loan is often used in the real estate market when a homeowner faces challenges in buying a new property while owning the current property. In such a scenario the owner has two options for purchasing the desired property. The owner can either sell the current property in order to generate funds for purchasing the desired property or they can take up a Bridge Loan to facilitate the down payment on the new property while waiting for the current property to sell. Using a bridge loan provides homeowners with flexibility and peace of mind during the transition. 

It is important to note that Bridge Loan comes with a higher rate of interest and is subject to considerable risk factors.  It is suitable for borrowers with excellent credit and low debt-to-income ratios.  

Companies often use bridge loans when the timeframe of expected funds is uncertain. For example, a company engaged in a six-month equity financing round might opt for a bridge loan to cover critical expenses such as payroll, rent, utilities, and inventory costs in the interim. This temporary financial support helps businesses maintain operations seamlessly until the long-term funding arrives. In such scenarios the lender has the power to ask for an equity share in return of the loan amount in order to protect its interests.

 

Example of a Bridge Loan

In the early 2000s, Tishman Speyer Properties and BlackRock Realty used a bridge loan to acquire the Stuyvesant Town-Peter Cooper Village in NYC, one of the era’s major real estate deals. This short term financing helped to purchase and provide quick funds until a more stable financing was secured.

 

FAQs

What is a Bridge Loan?

A bridge loan is the immediate and short term funding provided by an investment bank or venture capital firm to an individual or company in need of financial help when no other funding is available on an urgent basis. It typically has a very high interest rate.

Who issues the bridge loan?

A bridge loan is issued by a venture capital firm, by equity financing or an investment bank.

What is the interest rate on a bridge loan?

The interest rate of a bridge loan ranges from 12% to 18% along with the 0.35% to 2% processing fees.

What are the different types of bridge loan?

The four different types of Bridge loans are the Open Bridging Loan, Closed Bridging Loan, First Charge Bridging Loan and Second Charge Bridging Loan.

What is the time period of a bridge loan?

A bridge loan usually spans from 2 to 3 weeks long. It can be extended upto 12 months by backing up by a collateral.

What is bridge loan also known as?

The bridge loan is also known as interim financing, swing loan or caveat loan.

What are the advantages of Bridge Loan?

The main advantage of bridge loan is that it provides immediate cash flow in times of urgency until a permanent funding is secured.

What are the disadvantages of a Bridge Loan?

The main disadvantage of Bridge loan is the high interest rates compared to a traditional loan.

What are the qualification requirements for a bridge loan?

An excellent credit score and low debt to income ratio is preferred by a lender when lending bridge loans to a borrower.

Who offers bridge loans in India?

The bridge loans offered in India are the HDFC Bank Bridge Loan, Bank of Baroda Bridge Loan and many more.

Got any questions or point of view on our article? We would love to hear from you. Write to our Editor-in-Chief Jhumur Ghosh at [email protected]