A bridge loan is a form of temporary financing used until a permanent long-term loan can be finalized and arranged or additional funds are generated.
The term bridge applies to “bridging the gap” between the time a purchase is made (or current financing expires) and permanent financing can be put in place. The permanent loan will replace the bridge loan. Other terminology for a bridge loan include temporary and interim financing.
A bridge loan can be issued to or made by either a business or an individual. Bridge loans often charge higher interest rates, finance charges and fees when compared to traditional, permanent financing. But the benefit of these short-term loans is that they can be placed within a much shorter period of time. A bridge loan is typically secured by collateral such as real estate but can be secured by any appraised asset accepted by the lender.
Conventional financing requires that the collateral be appraised by an independent appraiser, legal ownership of the collateral reviewed, and the borrower’s credit, income and asset profile examined by an underwriter. An underwriter is an individual who determines if a loan application complies with lending guidelines.
This thorough underwriting and review of a long-term loan can often take weeks (sometimes months) before the financing is fully approved and issued. A bridge loan allows a borrower to make a purchase or replace an existing loan that may be expiring – by providing needed funds until the new loan is acquired.
The bridge loan is immediately paid off when the permanent loan is issued. Real estate investors commonly use bridge loans to assist in the purchase of all types of property.
Bridge financing doesn’t have to be a traditional short-term loan either. Many investors typically maintain a line of credit at a commercial bank or lending institution that can be used to issue bridge financing on a moment’s notice. Similarly, many home buyers may borrow from their credit cards or relatives to come up with the earnest money, down payment or full loan funds they need to purchase a new home.
A bridge loan can be as short or as long as needed, but bridge loans typically do not last more than a year, and only for larger projects. A bridge loan can collect monthly payments from the borrower, or the lender can allow interest to accrue up until the due date. A bridge loan needs to have a clear exit strategy in place as most bridge loans are due in full, or balloon, at the end of the loan term.
A bridge loan can also be placed on an existing property to help secure another property. In this instance, a bridge loan is typically a second lien secured by the home with the funds used as a down payment for a second property. A bridge loan in this example is most often encountered when consumers need to buy a second property before the existing home is sold. This type of bridge loans is paid off when the secured home ultimately sells.
Bridge loans, while having higher rates and fees, can be a practical financial solution when the need for quick funds are a necessity and can be an effective financial tool when buying and selling property.
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