A bridge loan is a short-term loan usually taken for a period of up to three years to help a person or entity stay afloat until larger or longer-term financing is arranged, an asset is sold, or expected money comes in. The terms caveat loan, swing loan, gap financing, interim loan, and in the UK bridging loan have the same meaning.
A bridge loan is usually more expensive than conventional financing – according to lenders, this is because of the additional risk. Interest rates tend to be higher, costs are amortized over a shorter period, and it usually contains other added fees.
The provider of the bridge loan may also require cross-collateralization and a smaller loan-to-value ratio (LTV). Lenders use LTV to asses borrower-risk. They are, however, generally arranged rapidly with the minimum of paperwork.
Bridge loans are useful when you need to move quickly, don’t have the money, but will have it soon.
Bridge loans used in commercial real estate deals
Bridge loans are commonly used for buying commercial real estate, to save a property from foreclosure, or to take advantage of a short-term opportunity in order to arrange long-term financing.
A bridge loan on a property is typically paid back when the borrower has sold it, arranged refinance with a traditional lender, his or her creditworthiness improves, or the real estate is completed or improved.
Imagine your house is for sale, but you have not yet found a buyer. You see another house you really want to buy, but don’t have the money yet. You could take out a bridge loan to secure the house purchase – the debt would be paid back, or a new mortgage arranged, when your house has been sold.
Bridge loans may be available for a predetermined timeframe (closed bridge loan), or open, meaning there is no fixed payoff date.
Bridge loans used in corporate finance
These types of loans may be use to inject funds so a company does not run out of cash between successive large private equity financings.
A distressed company looking for an acquirer or larger investor may need a bridge loan to keep it going until it finds one. In such cases the lender will probably obtain a significant equity position in connection with the loan.
Just before an acquisition or an IPO (initial public offering), a business may require final debt financing to secure working capital until the money comes in.
Bridging loans have become more popular in the United Kingdom since the 2008 global financial crisis. Gross lending in the country more than doubled, from £0.8 billion in 2011 to £2.2 billion in the year to June 2014. During this same period mainstream mortgage lending declined considerably.
According to the Merriam-Webster Dictionary, a bridge loan is:
“Money that a bank lends you for a short period of time until you receive the money that you are getting from another source (such as from selling your house).”
Some bridge loans can be massive. In July 2015, American health insurer Aetna Inc. was lining up a $16.2 billion bridge loan to fund its takeover of smaller rival Humana Inc. for $37 billion in cash and stock – the largest-ever acquisition in the insurance industry.
Video – How does a bridge loan work?