The Pros and Cons of Bridge Loan Financing

Bridge loan financing is interim financing that is generated using a bridge loan. A bridge loan is a short-term loan that is designed to provide temporary financing until a more permanent form of financing can be obtained. Bridge loans are usually used to finance the purchase and/or renovations of real estate properties. While bridge loan financing has it's benefits, it suffers from several drawbacks that borrowers should be aware of before they take out a bridge loan.

Benefits of Bridge Loan Financing

One of the biggest benefits of bridge loans is that the financing they provide is strictly short-term. Most other loans are geared towards long-term expenditures such as mortgage and college tuition. Those expenses require the borrower to pay the loan off over a long period of time. The longer the loan lasts, the more likely it is the borrower will suffer from some form of financial hardship that will make repaying the loan difficult. This, in turn, can compound the borrower's financial problems as penalty fees rise and the borrower struggles to get more funds to cover the mounting debt. Bridge loans, on the other hand, are designed to be repaid in full by the time long-term form of financing is secured.

This dovetails into another major benefit of bridge loan financing--the ability to choose repayment options. Borrowers can choose to repay the bridge loan before the permanent financing is secure or after. In the former case, the payments are structured in a way that allow the borrower to repay the loan in full over a certain limited period of time. If the borrower makes all the payments on time, his or her credit rating will improve significantly, allowing them to qualify for long-term loans they would otherwise be ineligible for. In the later case, the portion of the permanent funding is used to repay the bridge loan in full.

Downsides of Bridge Loan Financing

The biggest benefit of bridge loan financing is also it's biggest drawback. Because the borrower has to repay the loan quickly than he or she would a more long-term loan, the payments will be larger. This isn't an issue if the borrower has enough money to make all the payment, but if the borrower doesn't, he or she will have even harder time paying it back. Because of the length of their loan, the lenders are less likely to be flexible when it comes to late payments. They will charge larger fees and penalties, making it all that much harder for the borrower to repay the bridge loan.

The borrower can get around that by choosing to have the loan repaid once permanent financing is secured, but that has it's own drawback. For every month the loan isn't repaid, it gathers interest. This means that the actual payment will wind up larger (sometimes significantly so) than what the borrower would have paid if he or she made payments during the loan's actual term.

Another major downside of bridge loan financing is that it relies on a more permanent financing being available. Unfortunately, that isn't always guaranteed. As the collapse of the housing bubble demonstrated, if the lender runs into financial trouble, the funding may fall through, leaving the borrower scrambling to find some way to cover his or her expenses. If the borrower chose to repay the bridge loan using the permanent financing, the situation becomes catastrophic as the borrower is forced to repay the loan out of his or her own pocket. The borrower can try to deal with the situation by taking out another loan, but the debt will lower his or her credit rating, making it harder to get more financing.