True to its name a bridge loan “bridges” the gap between the current situation and more favorable financing in the future.
Bridge loans are used to define several unique types of financing, but the common thread between them is that the the bridge loan is used for a short term, is more expensive due to increased risk, and is made for the purpose of allowing the borrower to “move forward” with financing, construction, or acquisition activities they would not otherwise qualify for. Once the bridge loan allows the borrower’s process to continue, the future financing activities in that process create compensation for the maker of the bridge loan either in terms of paying off the debt, or granting a portion of the transactions profits.
Some examples of bridge loans are:
John Doe is selling Home A in order to buy Home B. He might seek a bridge loan in order to secure the financing on Home B without having to wait for Home A to sell.
John Doe comes across a distressed home that will be sold to the highest bidder in 2 days. He cannot get conventional financing on the home due to the short time frame and it’s distress. He could get a bridge loan, albeit at a very high interest rate and with a large amount of profit to the loan provider, in order to secure the property. He then would focus on getting the home financed which would enable him to pay back the bridge loan.
A builder has completed 75% of a house and is out of money. If he can finish it 100%, he knows he will make much more profit than selling it in its current, unfinished state. He might seek a bridge loan based on his plans and the future anticipated sales price. He’ll have to give up more interest to borrow it, but it will make him more profit when the house is complete.
In all of the above, the term bridge loan is used interchangeably with what many people know as “ hard money” or “ private money.” They are really the same thing. In fact, another way to look at a bridge loan would be as a credit card. In all 3 examples, the borrowers could have used a credit card which likely has higher interest and costs than a conventional loan. They could carry what they absolutely had to for a short period of time to secure their “end result” financing, or to “bridge the gap.”
Bridge loans for buyers selling one home and moving into another are now extremely rare. More common in this market are “ hard money” scenarios where lenders protect themselves by charging high costs and only loaning a low amount of the actual value of collateral.