Bridge loans are a powerful tool to further corporate growth, but if executed incorrectly they can also prove extremely expensive for your company. Simply put, a bridge loan is a temporary loan that is obtained while the borrower waits for approval for a long-term loan. There are various reasons that bridge loans can be difficult to work with, from terminology to timeline, but understanding how to implement them correctly can save you a lot of time, headache, and expense.
What are bridge loans?
Bridge loans are temporary loans that most often bridge the gap between the completion of construction work or real estate purchase and the approval of a long-term or permanent mortgage. Typically repaid over 3 years, they allow the borrower to meet current financial obligations like employee wages, utility bills and other accounts payable.
They can also be used when a property needs significant renovation (or new construction) before it will qualify for permanent financing. This allows the project to be renovated and repaired to an acceptable level, without requiring multiple additional loans.
Bridge loans are always asset-based, which means they are secured by the property they are leveraged against. If the borrower is either unable to repay the loan, or unable to find a permanent loan, the property is then used as collateral to pay off the loan.
When are bridge loans the right option?
Bridge loans are used in several types of property management. The most commonly used ones are for the purchase and improvement of an underutilized commercial property. This allows the borrower to buy the property, repair it, and then apply for a longer-term loan. They can also be used for investment real estate, like commercial, residential, or industrial properties, or for businesses looking for space to operate out of. Any scenario where a longer-term loan will be obtained over the next few years is a good fit for bridge loans to serve as a temporary capital solution.
How to use a bridge loan well
There are a few critical steps for proper implementation and use of a bridge loan. The first is to ensure that a timeline is created that accounts for full project completion and approval of a permanent loan. After a bridge loan is funded a borrower can have between 6 months and 3 years to pay off the loan, so understanding exactly how the loan will be paid off, and where permanent funding will be obtained from, is essential.
The second step is defining the exact work involved in this process. Knowing what repairs or work is being done allows the borrower to carefully monitor each step of the process, ensuring that costly mistakes don’t throw you off schedule for your permanent financing. If the loan is meant to be repaid through the sale of property, it is important to understand each step in the process and set a reasonable timeline for closing.
Finally, have an idea for a source of long-term or permanent funding to help close the loan. Bridge loans are a riskier investment, so they often come with a higher interest rate than a permanent loan. If you stay on the bridge loan for too long it can hurt your wallet. Having a clear idea of where longer-term funding will be coming from can help you to exit the bridge financing more quickly.
A bridge loan can be a valuable source of capital while a business waits for approval or works to repair their property. However, it can be a risky source as well. Our brokers can help you navigate the challenges – simply contact us if you’re interested in a bridge loan or other form of real estate financing.