A bridge loan, which is otherwise known as a bridging loan, caveat loan or swing loan, is a short-term financing for the borrower, who has already applied for a long-term financing.
The term of a bridge loan varies with vendors, but it can range between twelve months to three years. Sometimes, these loans are approved for a period of a couple of weeks too. One of the main features of this loan is the high rates of interest attached to it.
A bridge loan may also have other fees and costs, but the positive side is that the finance is arranged within a very short time with comparatively less documentation. Some people resort to bridge loans to benefit from the short term loan and also, as a short-cut for a long-term finance.
Features of Bridge Loans
As stated earlier, bridge loans are usually associated with high rates of interest for a very short term. The rate of interests of bridge loan ranges from 12% to 15% for a term of about 12 months to three years (the term may be as short as a few weeks). The lenders may charge an additional 2 to 4 points, as compared to long-term loans.
A bridge loan can be of two types - open and closed. A closed bridge loan has a predetermined time period and a well-defined repayment source for paying back the loan, whereas an open bridge loan does not need any such prerequisites.
A bridge loan is often associated with higher loan-to-value (LTV) ratios. The LTV ratio is derived by dividing the mortgage amount by the lesser of the selling price or appraised value. Usually, this ratio in bridge loan does not exceed 65% for commercial properties and 85% for residential properties.
The LTV ratio for a first charge bridging loan is higher than that of a second charge bridging loan (a first charge bridging loan will replace any outstanding mortgage and will have a first legal charge on your property and a second charge bridging loan will have a second charge on your property alongside your existing mortgage). Even though, the first charge bridging loans on residential property are for a shorter period of time, it is also regulated by the FSA.
Bridge Loan and Real Estate Industry
This loan is very much useful, in case of immediate financial requirement. In the real estate industry, this loan is mainly used for the immediate purchase of a property offered at a cheap rate, or for retrieving a property from legal proceedings initiated by a creditor for a loan that is in default. Builders or developers also resort to bridge loans, in case of projects pending for approval.
Without approval, there is no guarantee for any progress of the project and it is not entitled to get loans from the conventional sources. Hence, the developer opts for a bridge loan, which may be attached with high rates of interest. Once the project is approved, it is entitled for long-term loans from the conventional sources.
Generally, such long-term loans are for a bigger amount and with low interest rate. This amount can be used for repayment of the bridge loan and the completion of the project.
Apart from real estate investment, bridge loans are used in venture capital and corporate finance. Offering bridge loans is like gambling, as there is no guarantee of repayment. Hence, very few banks offer such loans.
Bridge loans are equally risky for the borrower, as it is associated with many terms and conditions regarding the interest rates, fees and penalties. It is really very important to go through these carefully and to search for any other means of raising funds, before accepting a bridge loan.
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