Bridge Loans Can Be a Useful Tool

By: Jonathan Hansen

Bridge financing or a bridge loan is a short-term loan that is used as a way to provide funding for the purchase of a new property while the borrower awaits the sale of his existing property. Unless everything is in proper order, it's tricky to coordinate the sale of one property and the purchase of another property so that the transactions occur simultaneously.

Bridge financing makes such transactions possible. They keep the borrower from ending up in a dire financial situation as can happen when forced to pay two mortgages at the same time. Bridge loans can be used either for business or for personal reasons.

Primarily short term in nature, the process for obtaining a bridge loan is similar to other types of loans. Most importantly, it's advisable to work with a lender who has abundant experience with this type of loan. Also, since the need for a bridge loan often arises with little advance notice, being pre-approved for such a loan is a good idea.

Typically, bridge loans are structured as interest-only loans, meaning that the borrower pays only the interest on the loan each month. The borrower continues with this repayment plan until the property the loan is being used for is sold. When the sale finally does occur, the proceeds of that sale are used to repay the principal. The principal payment typically is in the form of a one-time, lump-sum payment.

The lender does not need to worry too much about default because the borrower is required to put up collateral to secure the loan. This can be in the form of another piece of property, business machinery or inventory on-hand. But the lender may review the credit history of the applicant, business and any partners or others with an ownership interest to determine the level of risk.

The interest rate assigned to the bridge loan is based on several factors - the anticipated risk associated with the bridge loan, the prevailing interest rates and a premium added by the lender. Since bridge loans are short-term, generally not longer than two years, the lender has only a short time to make money on the deal. The profit is derived from the interest rate.

Expect to pay a higher rate of interest for a bridge loan. And remember the monthly payments on a bridge loan generally will be for interest only. Expect to pay off the bridge loan in full usually as a one time balloon payment as soon as the property is sold.

In the event that the property is not sold before the bridge loan matures, it can usually be converted to a conventional loan without paying a penalty. But it's always a good idea to double check this before assuming.

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