Taking a loan can be an overwhelming experience. There are many things to be considered, like what kind of loan you need, how to decide on the term of your loan, what you need to know about interest rates, etc. So, let us together explore a loan instrument called bridge loans.
What is a Bridge Loan?
Also called a bridging loan or a caveat loan or a swing loan, a bridge loan is a short-term loan, typically extending from 2 weeks to 2 years. It is used to bridge the gap between short-term requirements and larger financial requirements. The short-term cash infusion can help the borrower tide over till a larger financial assurance is put into place. Being an interim kind of product, it is a high-risk proposition for the borrower and the lender. Some of the characteristics of a bridge loan are:
- For shorter loan terms that are 2 weeks up to 1 year, very rarely extending till 2 years.
- Exorbitant interest rates to the order of 18% – 20% per year.
- Available to both corporates / businesses and individuals.
- Is secured either by using the home, shares or debentures as collateral.
How Does a Bridging Loan Work?
A bridge loan for individual consumers is commonly applied in the real estate sector, by consumers who take home-purchase decisions. A case in point is when the consumer wants to buy a new home before selling the current home, and need to make the down payment for the new home, a residential bridge loan is the go-to financial solution. To apply for the bridge loan, the owner must be at least 21 years of age and must be the rightful owner of the property. The amount of bridge loan provided by the lender is decided by the credit history, assets and liability of the applicant. The application process is similar to that of a home loan application.
A commercial bridge loan is offered to businesses in special situations. For example, if the company is awaiting to raise cash by the sale of stock, and want working capital money in the interim.
In both the above cases, the lender may require to cross-collateralise i.e. use the collateral that is in place for an existing loan as the collateral for the bridging loan. This poses a high risk to both the lender and the borrower and translates to a very high interest rate. It is also because a bridge loan generally carries a lower loan-to-value ratio than traditional loans, making the ROI less for the lender.
Pros And Cons of Bridge Loans
A bridge loan can come to the rescue in case you are waiting for a major financial decision to materialise and need funds in the interim.
- Fast Processing: Due to the urgent interim nature of the loan requirement, bridge loans are designed to have a faster and smoother application process, making funds available to the borrower much sooner than a traditional loan.
- No Cash Penalties: Many bridge loans do not have repayment penalties unlike traditional loans, but fall back on the collateral asset that the borrower stakes.
On the flipside, bridge loans come with their disadvantages:
- Overtly High Interest Rates: Bridge loans are significantly more expensive with large rates of interest and large processing and maintenance fees.
- Risk of Losing Asset: The very fact that the result is not certain puts you in jeopardy of not being able to pay the loan. This can put you at risk of losing your collateral asset altogether.
Many of the government and private banks in India offer bridge loans some of them are— HDFC Bank, ICICI, Tata Capital, Citibank, Standard Chartered, Aditya Birla Group, SBI etc. It is a great financial tool to help manage interim situations, by allowing you to bridge the gap between your dream home and real home!