What is Bridge Financing and How Does it Benefit Investors?

What is bridge financing? It is a way to close the gap between selling your old property and buying a new one. Here is what you need to know

What is Bridge Financing and How Does it Benefit Investors?

Updated 10-16-2023

For those who are new to investing in real estate, a common question is, what is bridge financing? A better question is, what is bridge financing and how does it benefit commercial real estate investors?

Bridge financing is short-term financing, sometimes referred to as private money or hard money. Bridge loans are typically made by private individuals and not banks. This means the interest rates on bridge loans are higher than bank loans.

But what are the different types of bridge financing? And what are the pros and cons of this financial arrangement? In this article, we will answer the question what is bridge financing? Here is everything you need to know.

What is bridge financing and how does it work?

Bridge financing, which is also called a bridge loan, is a way to help bridge the gap between closing on a current property and a new property. Bridge financing enables you to carry the mortgage on two properties for a specified amount of time. The typical amount of time for this is a maximum of 90 days.

In other words, a bridge loan is a short-term loan that is used until a person or a company can secure permanent financing or pays a current obligation. Bridge financing enables the borrower to meet those existing obligations by providing immediate cashflow. However, bridge loans have a relatively high interest rate. For this reason, bridge financing is often backed by some form of collateral, like the inventory of business or real estate.

What is bridge financing: how it works

Bridge financing is also known as interim financing, swing loans, or gap financing. As the name suggests, bridge loans bridge the gap when financing is required and not yet available. Bridge loans are used by both individuals and companies. Mortgage lenders can also customize bridge financing for numerous situations.

Bridge financing can essentially help property owners buy a new property while awaiting the sale of their current one. Borrowers are able to use the equity in their current property for the down payment on the purchase of the new property. Bridge loans afford homeowners more time and, with that, peace of mind while they wait.

What is bridge financing: homeowners

Mortgage lenders typically only offer bridge financing to borrowers that have low debt-to-income (DTI) ratios and excellent credit. Bridge financing rolls the loans of two properties together, which provides the buyer more flexibility while waiting for their old property to sell.

Most of the time, however, mortgage lenders only offer bridge financing worth 80% of the combined value of both properties. This means the borrower must have significant home equity in the first property. Otherwise, ample cash savings on hand will work.

What is bridge financing: businesses

Businesses use bridge financing when they are awaiting long-term financing and need money to cover expenses in the meantime. For instance, say a company is doing a round of equity financing that is expected to close within half a year. The company might choose to use bridge financing to provide working capital to cover its payroll, utilities, rent, or inventory costs, among many other expenses. This will work until the funding goes through.  

What is bridge financing: investors

Bridge financing benefits investors in three important ways:

  • Bridge financing allows investors to make their money go further. For example, if two properties come together at the same time, an investor can purchase both properties using a bridge loan on each purchase.
  • Bridge financing removes partners or family members from a deal. Investing with family members or business partners can be tricky. Bridge loans can remove other partners from the equation, allowing an investor more freedom and flexibility with a newly acquired asset.
  • Bridge loans fund faster than bank loans. If an opportunity is good, it won’t last long. Bridge loans have fewer requirements than bank loans and thus close quicker. Bridge financing allows investors to grab a fleeting opportunity before another investor snatches it up.

What are the different types of bridge financing?

Bridge financing bridges that gap between when a company’s money runs out and when it can expect to receive more funds later. Bridge financing is typically used to fulfill the short-term working capital needs of a company.

There are many ways to arrange bridge financing. The best option for any given entity or firm depends on the options open to them. For instance, a company in a relatively stable financial position that needs short-term help might have more options than a company that is struggling financially.

Let’s look at the different types of bridge financing out there:

  • Debt bridge financing
  • Equity bridge financing
  • IPO bridge financing

Here is a closer look at each to determine which may work best for you.

Debt bridge financing

One option is for your company to take out a high-interest, short-term loan. This is also known as a bridge loan. However, companies that need bridge financing through a bridge loan should exercise caution. Why? Because the interest rates can be so high that it causes further financial distress.

For instance, let's say your company is already approved for a bank loan of $500,000. However, the loan is divided into tranches. If the first tranche is set to come within six months, your company might require a bridge loan. Applying for a short-term, six-month loan may provide you with just enough funds until the first tranche is wired into your company’s bank account.

Equity bridge financing

Maybe your company does not want to incur debt with such high interest. In that case, you can connect with venture capital firms to provide a round of bridge financing. Doing this can provide your company with capital until it can raise a bigger round of equity financing.

Your company might choose to offer the venture capital firm equity ownership in exchange for the financing. If the venture capital firm believes it will ultimately turn a profit, it will likely take such a deal. It will also see its stake in your company increase in value.

IPO bridge financing

In investment terms, bridge financing is a method of financing that is used by companies before their IPO. In this case, bridge financing is designed to pay expenses associated with the IPO. It is therefore usually short-term. The funds raised from the offering immediately repay the loan liability, once the IPO is complete.

IPO bridge financing is often supplied by investment banks underwriting the new issue. The company receiving the bridge funding usually gives a number of shares to the underwriters at a discount, as payment. Essentially, the IPO bridge financing is forwarded payment for the new issue’s future sale.

What is bridge financing? It can help you bridge the gap between your old and new homes.

Photo alt text: What is bridge financing? It can help you bridge the gap between your old and new homes.

What is bridge financing: pros and cons

Before determining whether a bridge loan is right for you or your company, you first need to conduct your research. This usually involves weighing the pros and cons. In this section, let’s look at the potential benefits and risks of bridge financing.

What is bridge financing: the pros

Let’s look at some of the benefits of bridge financing:

  • Fast cash. Bridge financing can be ideal for time-sensitive—or quick—transactions. Some mortgage lenders can close on a bridge loan in as little as two weeks.
  • Payment flexibility. You can make interest-only payments or defer payments until your current property sells.
  • No contingency required. A bridge loan provides the money to settle on your new property, even if your previous property has yet to be sold.

What is bridge financing: the cons

Now, let’s look at some of the risks that come with bridge financing:

  • Equity requirements. Most mortgage lenders require a 20% minimum equity in the current property. That is enough of a barrier to entry for some.
  • Financing requirements. The mortgage lender may only offer bridge financing if you agree to use that same lender for your new mortgage.
  • High interest rates. Bridge financing usually comes with higher interest rates—and APRs—versus more traditional mortgages.

What is bridge financing: closing thoughts

When you purchase a new property and sell your old one, it can be difficult to get the timing just right. For example, maybe you are already a homeowner and found your new dream home, but the sale of your current property has yet to close. This is where bridge financing comes in.

Remember: there are different options when it comes to bridge financing, as well as pros and cons. This is why it is important to do your research to see if it is the right move for you.

To find out more about bridge financing, get in touch with one of the mortgage professionals we highlight in our Best of Mortgage section. Here you will find the top performing mortgage professionals across the USA.

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