Bridge loan
Encyclopedia
A bridge loan is a type of short-term loan
, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.
needs.
Bridge loans are typically more expensive than conventional financing to compensate for the additional risk of the loan. Bridge loans typically have a higher interest rate, points and other costs that are amortized over a shorter period, and various fees and other "sweeteners" (such as equity participation by the lender in some loans). The lender also may require cross-collateralization
and a lower loan-to-value ratio. On the other hand they are typically arranged quickly with relatively little documentation.
A bridge loan is similar to and overlaps with a hard money loan
. Both are non-standard loans obtained due to short-term, or unusual, circumstances. The difference is that hard money refers to the lending source, usually an individual, investment pool, or private company that is not a bank in the business of making high risk, high interest loans, whereas a bridge loan refers to the duration of the loan.
A bridge loan may be closed, meaning it is available for a predetermined timeframe, or open in that there is no fixed payoff date (although there may be a required payoff after a certain time).
A first charge bridging loan is generally available at a higher LTV than a second charge bridging loan due to the lower level of risk involved, many UK lenders will steer clear of second charge lending altogether.
Lower LTV's may also attract lower rates again representing the lower level of underwriting risk although front-end fees, lenders legal fees, and valuation payments may remain fixed.
and other corporate finance
for several purposes:
. As is common in such cases, KKR planned for the newly private company to borrow money by issuing corporate bonds
. To ensure the money would be available, KKR sought $1.6B in bridge loan guarantees, for which it promised to pay 8.75% interest for 60 days and 11.75% thereafter. At KKR's option, these loans could then be replaced with eight-year corporate bonds (in effect, a put option
) paying 11.75%. In return for the loans and guarantees, KKR was offering roughly 2% in fees.
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.
Description
A bridge loan is interim financing for an individual or business until permanent or the next stage of financing can be obtained. Money from the new financing is generally used to "take out" (i.e. to pay back) the bridge loan, as well as other capitalizationCapital expenditure
Capital expenditures are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset with a useful life extending beyond the taxable year...
needs.
Bridge loans are typically more expensive than conventional financing to compensate for the additional risk of the loan. Bridge loans typically have a higher interest rate, points and other costs that are amortized over a shorter period, and various fees and other "sweeteners" (such as equity participation by the lender in some loans). The lender also may require cross-collateralization
Cross-collateralization
Cross-collateralization is a term used when the collateral for one loan is also used as collateral for another loan. If a person has borrowed from the same bank a home loan secured by the house, a car loan secured by the car, and so on, these assets can be used as cross-collaterals for all the loans...
and a lower loan-to-value ratio. On the other hand they are typically arranged quickly with relatively little documentation.
Use
Bridge loans are often used for commercial real estate purchases to quickly close on a property, retrieve real estate from foreclosure, or take advantage of a short-term opportunity in order to secure long-term financing. Bridge loans on a property are typically paid back when the property is sold, refinanced with a traditional lender, the borrower's creditworthiness improves, the property is improved or completed, or there is a specific improvement or change that allows a permanent or subsequent round of mortgage financing to occur. The timing issue may arise from project phases with different cash needs and risk profiles as much as ability to secure funding.A bridge loan is similar to and overlaps with a hard money loan
Hard money loan
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued by private investors or companies...
. Both are non-standard loans obtained due to short-term, or unusual, circumstances. The difference is that hard money refers to the lending source, usually an individual, investment pool, or private company that is not a bank in the business of making high risk, high interest loans, whereas a bridge loan refers to the duration of the loan.
Characteristics
Bridge loan interest rates are usually 11–15%, with typical terms of up to 12 months 2–4 points may be charged. Loan-to-value (LTV) ratios generally do not exceed 65% for commercial properties, or 80% for residential properties, based on appraised value.A bridge loan may be closed, meaning it is available for a predetermined timeframe, or open in that there is no fixed payoff date (although there may be a required payoff after a certain time).
A first charge bridging loan is generally available at a higher LTV than a second charge bridging loan due to the lower level of risk involved, many UK lenders will steer clear of second charge lending altogether.
Lower LTV's may also attract lower rates again representing the lower level of underwriting risk although front-end fees, lenders legal fees, and valuation payments may remain fixed.
Examples
- A bridge loan is often obtained by developers to carry a project while permit approval is sought. Because there is no guarantee the project will happen, the loan might be at a high interest rate and from a specialized lending source that will accept the risk. Once the project is fully entitled, it becomes eligible for loans from more conventional sources that are at lower-interest, for a longer term, and in a greater amount. A construction loanConstruction loanIn the broadest sense of the term, a Construction Loan is any loan where the proceeds are used to finance construction of some kind. In the United States Financial Services industry however, the term is used to describe a genre of loans designed for construction and containing features such as...
would then be obtained to take out the bridge loan and fund completion of the project.
- A consumer is purchasing a new residence and plans to make a down payment with the proceeds from the sale of a currently owned home. The currently owned home will not close until after the close of the new residence. A bridge loan allows the buyer to take equity out of the current home and use it as down payment on the new residence, with the expectation that the current home will close within a short time frame and the bridge loan will be repaid.
- A bridging loan can be used by a business to ensure continued smooth operation during a time when for example one senior partner wishes to leave whilst another wishes to continue the business. The bridging loan could be made based on the value of the company premises allowing funds to be raised via other sources for example a management buy in.
- A property may be offered at a discount if the purchaser can complete quickly with the discount off setting the costs of the short term bridging loan used to complete. In auction property purchases where the purchaser has only 14–28 days to complete long term lending such as a buy to let mortgage may not be viable in that time frame where as a bridging loan would be.
In Corporate Finance
Bridge loans are used in venture capitalVenture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as...
and other corporate finance
Corporate finance
Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks...
for several purposes:
- To inject small amounts of cash to carry a company so that it does not run out of cash between successive major private equity financings
- To carry distressed companies while searching for an acquirer or larger investor (in which case the lender often obtains a substantial equity position in connection with the loan)
- As a final debt financing to carry the company through the immediate period before an initial public offeringInitial public offeringAn initial public offering or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises...
or an acquisition.
Example
In December 2010, Kohlberg Kravis Roberts (KKR) and partners marketed a bridge loan for its upcoming acquisition of Del Monte FoodsDel Monte Foods
Del Monte Foods is an American food production and distribution company headquartered in San Francisco, California. Del Monte Foods is one of the country's largest producers, distributors and marketers of branded food and pet products for the U.S. retail market, generating approximately $3.6...
. As is common in such cases, KKR planned for the newly private company to borrow money by issuing corporate bonds
Corporate bond
A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date...
. To ensure the money would be available, KKR sought $1.6B in bridge loan guarantees, for which it promised to pay 8.75% interest for 60 days and 11.75% thereafter. At KKR's option, these loans could then be replaced with eight-year corporate bonds (in effect, a put option
Put option
A put or put option is a contract between two parties to exchange an asset, the underlying, at a specified price, the strike, by a predetermined date, the expiry or maturity...
) paying 11.75%. In return for the loans and guarantees, KKR was offering roughly 2% in fees.
See also
- Hard money lenders
- Commercial lendersCommercial lender (US)In the United States a commercial lender offers loans backed by hard collateral. In most cases this is real estate, but it can also include factoring, non-conforming assets, or other sources of collateral.-Commercial lending practices:...
- Non-conforming loanNon-conforming loanA non-conforming loan is a loan that fails to meet bank criteria for funding.Reasons include the loan amount is higher than the conforming loan limit , lack of sufficient credit, the unorthodox nature of the use of funds, or the collateral backing it. In many cases, non-conforming loans can be...
- Bridge financingBridge financingBridge financing is a method of financing, used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash. Bridge financing is commonly used when the cash flow from a sale of an asset is expected after the cash outlay for the purchase of an asset...
- Mortgage Investment CorporationMortgage Investment CorporationA Mortgage Investment Corporation or MIC is an investment and lending company designed specifically for mortgage lending in Canada. Owning shares in a Mortgage Investment Corporation enables you to invest in a company which manages a diversified and secured pool of mortgages...