What Is a Bridge Loan and How Does It Work, With Example

What Is a Bridge Loan?

Bridge loans, often called bridge financing or bridging loans, serve as short-term financial solutions to provide immediate cash flow until permanent financing is secured or existing obligations are met. These loans are characterized by higher interest rates and typically require collateral such as real estate or business inventory.

Commonly used in real estate transactions, bridge loans enable homeowners to purchase a new property before their current house sells, using the equity as a down payment. Businesses also rely on bridge loans to cover interim expenses like payroll and rent while awaiting long-term funding. Although convenient, these loans often entail higher interest and origination fees compared to traditional loans, necessitating careful consideration by borrowers.

Understanding the Mechanics of Bridge Loans

Also known as interim financing, gap financing, or swing loans, bridge loans bridge the gap during times when financing is needed but not yet available. Both individuals and companies use bridge loans, and lenders can customize these loans for many different situations.1

Homeowners can use bridge loans to buy a new house while waiting to sell their current one. Borrowers use the equity in their current home for the down payment on the purchase of a new home while they wait for their current home to sell.

A bridge loan gives the homeowner some extra time and, more often than not, some peace of mind while they wait. However, these loans usually have higher interest rates than options like a home a home equity line of credit (HELOC).2

Lenders typically offer real estate bridge loans only to those with excellent credit and low debt-to-income (DTI) ratios. Bridge loans roll the mortgages of two houses together, giving the buyer flexibility as they wait for their former house to sell. However, in most cases, lenders only offer real estate bridge loans worth 80% of the combined value of the two properties, meaning that the borrower must have significant home equity in the original property or ample cash savings on hand.2

Businesses turn to bridge loans when they are waiting for long-term financing and need money to cover expenses in the interim. For example, imagine a company is doing a round of equity financing expected to close in six months. It may opt to use a bridge loan to provide working capital to cover its payroll, rent, utilities, inventory costs, and other expenses until the round of funding goes through.

Real-World Example: How Bridge Loans Facilitate Major Transactions

When Olayan America Corp. wanted to purchase the Sony Building in New York City in 2016, it took out a bridge loan from ING Capital. The short-term loan was approved very quickly, allowing Olayan to seal the deal on the Sony Building with dispatch. The loan helped to cover part of the cost of purchasing the building until Olayan secured more permanent, long-term funding.4

Comparing Bridge Loans and Traditional Financing Options

Bridge loans typically have a faster application, approval, and funding process than traditional loans. However, in exchange for the convenience, these loans tend to have relatively short terms, high interest rates, and large origination fees.

Borrowers usually accept these terms to get fast, convenient access to funds. They are willing to pay high interest rates because they know the loan is short-term and plan to pay it off quickly with low-interest, long-term financing. In addition, most bridge loans don’t have repayment penalties.

The Bottom Line

A bridge loan—short-term financing used until a person or company secures permanent financing or settles an existing obligation—is often used in residential real estate, but many types of businesses use them as well. Homeowners can use bridge loans toward the purchase of a new home while they wait for their current home to sell. Businesses seek bridge loans when they are awaiting longer-term financing and need money to cover expenses in the interim. But these loans normally carry a higher interest rate than other available credit facilities.