Bridge Finance: Meaning, Types, And How It Works

A bridge loan, also known as interim financing or a swing loan, is a short-term loan that serves as a temporary solution to bridge a financial gap. While it typically can be utilised in situations where immediate funds are needed, it is commonly used in real estate transactions for individuals and businesses. In this blog, we will explore the concept of bridge loans, how they work, their characteristics, and their potential benefits and risks. Keep reading further to know more.

What is a Bridge Loan?

A bridge loan is a kind of short-term loan that is designed to provide borrowers with financing during any transitional period. As the name suggests, it “bridges” the gap between the immediate need for cash and the availability of a more permanent source of funds.

Sometimes, individuals and businesses find themselves in need of immediate funds while waiting for loan approval. In such situations, they can apply for a bridge loan until they secure permanent financing to cover expenses.

Features of a Bridge Loan

Let's take a look at the features of bridge financing:

• Duration: These loans are intended for short-term financing; they're typically offered for a short duration, usually between two weeks and twenty-four months

• Collateral: Bridge loans are secured loans, i.e., they require collateral like real estate property or business inventory to support them.

• Interest Rates: They usually incur a much higher interest rate, which is an important point for any potential borrowers to remember.

Bridge Loans vs Traditional Loans

Aspect	Bridge Loans	Traditional Loans
Purpose	Short-term funding to bridge a financial gap, often during property transitions.	Long-term financing for sustained needs like mortgages or business expansion.
Loan Tenure	Typically 6 to 12 months.	Several years, often 10–30 years for mortgages.
Interest Rates & Charges	Higher rates and fees due to short duration and increased risk.	Generally, lower interest rates and fees.
Security	Usually secured against existing property or assets.	Secured or unsecured, depending on loan type.
Approval Time	Faster approval, often within days.	Longer approval process, sometimes weeks.
Repayment	Requires a clear exit strategy (e.g., sale of asset, refinancing).	Structured repayment schedule over the loan term.
Suitability	Best for temporary, urgent funding needs.	Suitable for long-term financial planning.

How Does a Bridge Loan Work?

Bridge financing can be beneficial for both individuals and businesses:

For Individuals:

Someone looking to buy a new home while still in the process of selling their current one can use a bridge loan to fund the down payment. This allows them to proceed with the new purchase while awaiting the sale of their existing property.

For Businesses:

Bridge financing can provide immediate cash flow to cover operational expenses while waiting for permanent financing. For instance, a company raising funds through equity bridge financing expected to close in six months might take a bridge loan to cover working capital needs in the interim. In both cases, the bridge loan serves as a temporary solution to tackle financial challenges and ensure continuity.

Bridge Loan Example:

Here is an example of how bridge financing works:

Let’s say you obtain a bridge loan of ₹70 Lakh against your current home, which is valued at ₹1 crore. You still have an outstanding balance of ₹50 Lakh on your existing mortgage. From the ₹70 Lakh, ₹50 Lakh will go towards repaying the mortgage, and ₹2 Lakh will be used to cover the closing costs. After settling these liabilities, you’ll be left with ₹18 Lakh, which can be used as a deposit for your new home or other related expenses.

Different Types of Bridge Loans

There are mainly four types of bridge loans. Lenders offer these financing options to borrowers depending on their creditworthiness and preferred terms. Here's a list of the different classifications:   

1. Closed Bridge Loans

A closed bridging loan has a predetermined source of repayment or exit strategy. Like other categories of bridge loans, it is short-term in nature. Having a fixed payoff date reduces the uncertainties for the lender, making it less risky than open bridge loans. As a result, lenders offer lower interest rates on this type of loan.

2. Open Bridge Loans

An open bridge loan does not have a specific repayment source or exit strategy. Here, the borrower has the freedom to repay the loan within a wider range of time frames. This loan category is riskier than the closed ones. The lender evaluates your financial position and creditworthiness more carefully before approval.

3. First Charge Bridging Loan

A first-charge bridging loan is a temporary financing choice that is secured by having the first claim on a property. The term “first charge” means that the bridging loan has the highest priority when it comes to other loans or claims on the property. It also means that the bridge loan lender has the first right to the property’s value if the borrower fails to repay the loan. This gives the lender a greater level of security compared to other loans or charges that may come later.

4. Second Charge Bridge Loan

A second charge bridging loan is a type of short-term loan taken out when there is already an existing mortgage or “first charge” on the property. As these loans carry a higher risk of default, lenders typically limit the repayment term to 12 months or less, and they often come with higher interest rates.

With second-charge bridging loans, the lender usually begins the repayment period only after all liabilities from the first-charge loan have been settled.

Also Read - Short Term Loan Vs Long Term Loan: Differences, Benefits, Characteristics

Pros and Cons of Bridge Financing

There are various pros and cons of bridge loan financing. Here are a few examples:

Pros

• Enables you to buy a new property before selling the current one.

• Let's you make offers without sale contingencies.

• Provides quick funds during sudden transitions.

• Acts as a short-term solution for urgent financial needs.

• May offer interest-only or deferred payments until the property sells.

Cons

• Bridge financing typically comes with higher interest or annual percentage rates compared to standard loans.

• Most lenders require homeowners to have at least 20% equity in their property before approving a bridge loan.

• Only select financial institutions offer bridge loans, so availability may be limited.

• Managing two mortgages at once can be financially challenging.

• If the borrower is unable to sell their existing property in time, it could lead to foreclosure. 

When Should You Consider Applying for a Bridge Loan and Why?

A bridge loan can come in handy if you want to buy a new house before selling your current one. You can use the borrowed money to pay off your existing mortgage and use the rest as a down payment for the new home. It can also serve as a second mortgage to cover the down payment.

If you own a business, you can use this short-term financing option to cover expenses while you await your long-term financing funds. The borrowed money can also become useful for business expansion , say, in the form of purchasing real estate. Also, this type of loan can be used to make the most of time-limited opportunities to acquire inventory and other essential resources for your business.

Other scenarios where a bridge loan may be useful in property transactions:

• You need to purchase a new property quickly due to a career move or relocation.

• The completion date for your new home is scheduled before the current property sale is finalised.

• You prefer to secure your next property before selling your existing one.

• Sellers in your desired area aren't comfortable with contingent purchase offers.

Considerations for Individuals Applying for Bridge Loans

It is important to note that financial institutions typically only provide real estate bridge loans up to 80% of the combined value of both properties. This means that you need to have substantial equity in your original property (they must already own a significant portion of their current home) or have a good amount of cash savings available to meet the lender’s requirements.

How Should You Apply for a Bridge Loan?

1. Research Lenders: Start by comparing banks, NBFCs, private lenders, and online platforms that offer bridge financing. Look at interest rates, fees, loan terms, and customer reviews to find a lender that fits the needs and timeline.

2. Check Eligibility: Ensure the lender’s criteria are met, which typically include having sufficient equity in your current property (or strong business financials), a solid credit score, and a clear repayment plan or exit strategy, such as selling your existing home or securing long-term financing.

3. Prepare Documents: Gather key documents, including income proof (salary slips, ITRs, and bank statements), property documents (sale deed or title deed, latest property tax receipt), and business financials (GST returns, audited balance sheets, profit and loss statements) if applying for a commercial bridge loan.

4. Fill Form and Submit Application: Complete the lender’s application form, either online or in person, and upload all required documents. Make sure to authorise credit and background checks as part of the process.

5. Loan Approval, Disbursal & Management: Once the application is processed, the lender will notify you within a few hours. Upon approval, funds are disbursed quickly, usually within a week. Begin repayments as agreed, and ensure the loan is managed actively until it's paid off through sale proceeds or refinancing.

Bridge Loan Alternatives

Here are some efficient alternatives:

Personal Loan: A Personal Loan can be a strong alternative to a Bridge Loan, especially for immediate funding needs. If the borrower has a good credit score and a low debt-to-income (DTI) ratio, they may qualify for better interest rates compared to a typical Bridge Loan. However, terms and conditions vary between lenders.

HELOC (Home Equity Line of Credit): A HELOC functions like a credit card, allowing individuals to borrow against the equity in their current home. Interest is charged only on the amount used, not the full credit limit. HELOCs often offer more favourable interest rates than bridge loans. However, many lenders may not approve a HELOC if the borrower plans to sell their home soon.

80/10/10 Loan (Piggyback Loan): This option involves taking out two mortgages: the first covers 80% of the property value, the second covers 10%, and the borrower provides the remaining 10% as a deposit. This structure helps reduce the need for a large upfront deposit.

Home Equity Loan: A home equity loan can be a great option if the borrower knows exactly how much money they need for their new home’s deposit. It provides a lump-sum amount based on the current home’s equity, often with longer repayment terms (up to 240 months) and lower interest rates than bridge loans.

Business Line of Credit: Similar to a HELOC, this option allows people to borrow as needed and pay interest only on the amount used. Repayment terms may extend up to 120 months. However, business lines of credit can be harder to qualify for and often come with higher interest rates than bridge loans.

To Conclude

Bridge loans offer quick financing over a short period for property purchases and other urgent needs. While they provide flexibility, it's important to weigh the costs and risks involved. Assess your financial situation carefully and explore alternatives before proceeding.

Seeking advice from a financial expert can help you make the right decision, as can choosing the right lending partner. Poonawalla Fincorp is a top NBFC in India that offers loans with attractive interest rates and facilities. Reach out today to know more about how we can help!

Frequently Asked Questions

What is the time period of a bridge loan?

In India, the general time period of a bridge loan is between two weeks and two years. This means that you have a flexible window of time to repay the loan based on your specific needs and circumstances.

Is a bridge loan secured or unsecured?

Bridge loans are typically secured loans. They have relatively high interest rates and are usually backed by some form of collateral, such as real estate or business inventory. If you have a good credit history and an asset that you can use as collateral, you can easily apply for a bridge loan to meet your short-term financial needs.

Can we extend bridge loans?

Bridge loans are typically short-term loans with repayment periods ranging from six to twelve months. Due to their high-risk and short-term nature, lenders usually do not offer extensions. It's important to have a clear repayment strategy in place before taking one.

What is the most important difference between long-term and bridge loans?

Since bridge loans are short-term and typically used for purchasing new property, they tend to carry higher interest rates compared to long-term loans.

What are the benefits of bridge loan financing?

Most bridge loans typically have a faster application, approval, and funding process than traditional loans. This is useful when a company requires quick access to funds for real estate transactions or any other needs. Bridge financing provides the necessary capital to cover operational costs like salaries and rent.

How to apply for a Personal Loan?

When applying for a Personal Loan with Poonawalla Fincorp, follow these steps to complete the simple and fast procedure:

1. Click on the ‘Apply Now’ button and enter all the necessary information.

2. Fill in your personal information, such as date of birth, Permanent Account Number (PAN) card details, and residential and employment details.

3. Upload the necessary documents and hit the ‘Submit’ button.