A bridge loan is a short-term financing tool meant to furnish immediate and crucial cash flow until permanent financing is secured. This occurs often when traditional lenders might be reluctant to grant the funding unless the loan is secured by high-value assets used as collateral. On the other hand, however, before completing the purchase, a proposed buyer might be in desperate need of cash to meet the seller’s requests. Private lenders emerge to offer a “bridge” in money in these situations, thus allowing the parties to perfect the transaction.
Two of the most significant features of bridge loans are the short terms and the relatively high-interest rates. The latter is justified by the extra risks incurred by the lender in dealing with a less creditworthy borrower. The term is on average between six and twelve months, given that the goal of the borrower is to pay off the bridge loan as soon as possible and obtain a refinancing with another lender under more conventional terms (lower interest rates and payable in a range between 5 and 20 years). However, it is somewhat common that the borrower cannot pay off the bridge loan at maturity, which will bring the lender to accept a conversion into a long-term loan and increased interest rates.
Bridge loans carry several transaction fees to be incurred by the borrower: commitment fees to the lender for the initial processing and, therefore, will be due even if the financing is not completed; origination fees to the lender that are paid when funds are disbursed; agent’s fees to any broker that introduced the parties; attorneys’ fees to lender’s counsel for putting together the loan documents; prepayment fees to the lender, in the event the borrower wishes to pay off the loan before maturity; and refinancing fees to the lender, should the borrower not be able to meet its obligations at maturity and chooses to refinance.
Overall, bridge loans might not be the most convenient options either for the borrowers but are very attractive in specific instances, such as:
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Providing cash to complete a real estate purchase.
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Covering day-to-day expenses while a company awaits other investments.
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Taking up limited-time opportunities on inventory.
On the other hand, private lenders face considerable risks in structuring bridge loans that are “lightly” secured by the borrower’s assets and can realize quick and large profits with these transactions.