What is a Bridge Loan?
Bridge Loans represent a source of short-term financing until the borrower – either a person or corporation – secures long-term financing or removes the credit facility altogether.
- What is the definition of a bridge loan?
- Which entities typically provide bridge loans?
- What are the pros/cons to bridge loans?
- How do bridge loans work in the context of real estate and M&A?
Table of Contents
Bridge Loans Definition
Bridge loans, or “swing loans,” represent short-term, temporary financing provided with the intention to last around six months and up to one year.
Such short-term loans are common in:
- Real Estate Transactions: Finance the purchase of a new home prior to selling the current residence.
- Corporate Finance: Fund M&A deals where more financing commitments are needed for the deal to close.
In either scenario, the bridge loan is designed to provide near-term funding during a transitionary period.
The bridge loan closes the gap between the date of the new purchase (i.e. transaction close) and the date when permanent financing has been found.
Bridge Loans in Real Estate Transactions
Under the context of real estate, bridge loans are utilized when the buyer has insufficient funds to purchase the new property without first selling the property still in their possession – i.e. that is currently on the market.
Typically, bridge loans are characterized by the following traits:
- Secured with Current Home Pledged as Collateral
- 6-Month to 1 Year Lending Term
- Same Lender is Often Financing New Mortgage
- Borrowing Ceiling of ~80% of Original Home’s Value
In effect, the bridge loan financing commitment offers homebuyers the opportunity to purchase a new house prior to actually selling their current home.
Pros/Cons of Bridge Loans
Pros of Bridge Loans
- Quick Source of Financing
- Increased Flexibility (i.e. Bypass Hurdles with Further Delays)
- Removed Contingencies and Doubt from Other Parties (e.g. Seller)
- Could Directly Result in a Successful Deal
Cons of Bridge Loans
- Expensive Fees (i.e. Upfront Charges, Higher Interest Rates)
- Risk of Losing Collateral
- Origination Fees (i.e. “Commitment Fees”)
- Short-Term Financing with Penalties (e.g. Funding Fee and Drawn Fees to Incentivize Repayment)
- Approval Required Strong Credit History and Stable Financial Performance
Bridge Loans in M&A Transactions
In M&A, bridge loans function as an interim financing option used by companies to reach their required total financing needs with a short-term loan.
Similar to bridge loans in real estate, these short-term facilities are arranged with the intention for long-term financing from the capital markets to replace it (i.e. “taken out”).
Most often, the provider of the bridge loan comes from an investment bank, or a bulge bracket bank, to be more specific.
In the event of a time-sensitive transaction where financing is needed promptly or else the deal might collapse, the investment bank can step in and provide the financing solution to ensure the deal closes (i.e. reduce the uncertainty).
Otherwise, the funding – which can come in the form of debt or equity – is contributed by a venture capital (VC) firm or a specialty lender.
Bridge Financing M&A Lending Terms
But generally, the interest rates on bridge loans are higher than typical rates under ordinary circumstances – in addition, lenders often place provisions where the interest rate increases periodically across the term of the loan.
Sellers in M&A deals can require the buyer’s financing commitments to be fully secured as a condition to proceed further in the process, so buyers often turn to investment banks for support in obtaining financing commitments.
Note that bridge loans in M&A are NOT meant to be a long-term source of capital.
In fact, corporate banks aim to avoid bridge loans that remain outstanding for too long, which is why conditional provisions are included to push the client to replace such facilities as soon as possible.