Understanding How Bridge Loans Work: Advantages And Disadvantages

Bridge Loan can be defined as a type of gap financing arrangement in which the borrower can gain access to a short-term financial solution or loan in order to meet a short-term liquidity requirement.

It is also referred to as short-term financial solution to meet current obligations while waiting to secure for permanent financing. It serves to provide immediate cash flow in cases wherein funding is required but is not yet available.

Bridge loans are used to cover up an immediate financial need while waiting for a long-term funding solution.

Primary Features

Bridge loans are beneficial in bridging the gap between short-term cash requirements and long-term financing. This financial solution is typically extended for up to 12 months. And, it is being offered with over-the-top interest rates which can be a huge drawback for many borrowers.

Such loans are usually backed-up by collateral in the form of assets, business inventory, real estate property or equity. Bridge loans are accessible to both individuals and companies that need to meet specific obligations.

Just like fix-and-flip loans to some extent, bridge loans can also be arranged within a shorter period of time and with very little documentation.

The terms can also be flexible depending on the arrangement and collateral used. However and in either way, the interest rates are always significantly higher.

Homebuyers who want to grab at an opportunity to buy a property can settle for bridge loans while waiting for a permanent and long-term funding solution. Examples of these are investors who fix and flip houses and home buyers who are buying a new property while waiting for their old house to sell.

Sample Case Scenario for Bridge Loans

For instance, there is a lag between the actual purchase of a new property and the disposal of another one. The buyer may opt for a bridge loan to meet requirements and facilitate the transaction.

In such scenario, the property which is being sold serves as the collateral for the loan. As soon as long-term financing becomes available, it is used to settle the bridge loan as well as meet other needs for capitalization.

In its broadest sense, bridge loans are primarily used in real estate for the purpose of retrieving a property from foreclosure as well as to close on a property purchase immediately.

Advantages of Bridge Loans

  1. Allows real estate investors and home buyers to secure opportunities which they might otherwise miss due to lack of immediate funding.
  2. A homeowner who is considering on buying a new house may put a contingency in the agreement which states that he will only buy the property after the old house has been sold.
  3. Qualifying for a loan and loan approval is usually faster compared to conventional loans types.
  4. Allows flexible payment terms depending on the contract or agreement with the lender.
  5. Borrowers can start paying off the loan amount before or right after long-term financing becomes available or after the old property has been sold.
Bridge loans have high-interest rates which could be a problem in case funding gets delayed or becomes unavailable.

Disadvantages of Bridge Loans

  1. Bridge loans are costly options due to extremely high interest rates and other associated fees such as valuation payments, lender legal fees and other charges.
  2. Some bridge loan lenders tend to insist on borrowers to take a home mortgage on them thus creating limitations on their ability to make rate comparisons with other lending firms.
  3. Bridge loans can leave borrowers with the burden of having to pay for two mortgages and a bridge loan while waiting for the old house to sell or for the long-term financing to kick off.
  4. If the borrower fails to settle his loan obligation, the lender can foreclose on the property right away (depending on what’s stipulated in the contract). This can leave the borrower with no home and in a lot of financial distress.