Published on April 8, 2022 in the Rochester Business Journal

A bridge loan can be thought of as a short-term funding mechanism to “bridge” the gap between a project’s inception and its eventual completion, at which point more permanent financing is generally, but not always, put in place. It’s effectively a short-term loan, collateralized with assets that may or may not be related to the final project itself. The terms and types of bridge loans can vary, but their use can offer a variety of benefits to those that take advantage of them, turning otherwise undoable projects into viable long-term endeavors. 

One of the most popular types of bridge loans is called a portfolio loan. Here, one uses the non-retirement assets in their investment account as collateral for a short-term credit facility. These non-retirement assets generally consist of stocks, bonds, mutual funds, exchange-traded funds, or other marketable securities, and it’s common to borrow up to 80% of the fair market value of these assets (using the assets themselves as collateral), to fund a special project. It may also be possible to borrow against an employer-sponsored retirement account (i.e. 401(K), 403(B), or 457 plan), but, unfortunately, it’s not possible to borrow against or otherwise leverage assets in a traditional IRA or Roth IRA account.

Lately, and with the boom we’ve seen in local and national real estate sales, portfolio loans have increased in popularity, as a means of tapping into an immediate source of cash, to put a non-contingent offer in for the purchase of residential real estate. Non-contingent means one’s offer to purchase a new home isn’t contingent or dependent upon the sale of their existing home. Bridge loans of this nature are typically granted for one to three years and generally require monthly payments of interest-only on the outstanding balance of the loan. Once the new property is purchased, the owner can obtain permanent, more conventional mortgage financing and use the proceeds from the permanent financing to retire the outstanding balance on the bridge loan. From that point forward, payments of principal and interest are typically made to reduce the permanent mortgage balance over time.

Another popular type of bridge loan is known as a construction loan. Commonly associated with a business expansion, funds are gradually advanced to a borrower, to fund the construction of a new building or the addition to an existing building. Funds are advanced in a series of progress payments as the work on the new project takes place, and one or more parties including inspectors, project managers, engineers, and lenders sign off on each phase of construction (i.e. each progress payment), to verify that all required tasks up to that point have been completed, and before the next phase of construction is authorized to begin.

Much like a portfolio loan, construction loans generally require monthly payments of interest only, based on the total amount of money advanced at the end of each period (cumulatively). Upon completion of the project and once a permanent Certificate of Occupancy is issued by the governing municipality, the borrower can then close on a permanent, more conventional mortgage loan and retire the balance of the construction loan with the proceeds of the new credit facility. Just like the conversion of a portfolio loan to a permanent mortgage loan for the purchase of residential real estate, monthly payments of principal and interest are then made to reduce the outstanding balance of the new mortgage loan over time.

Aside from portfolio and construction loans, a business line of credit can be viewed as a special type of bridge loan. Here, and particularly for manufacturers of finished goods, capital is first needed to purchase raw material inventory, then to fund the transformation of that inventory into a finished good, and lastly, to cover the period between the time when the good is sold until the time that payment is collected. To address this need for working capital and to “bridge” the funding gap that exists until all these steps have taken place, a business owner can draw on a line of credit and make monthly payments of interest only on the debt until the principal is able to be repaid. In these cases, there is typically no conversion to permanent financing involved (although the line of credit itself may be permanent). The borrower simply continues to pay down the line of credit as receivables are collected and draw fresh money from the line to fund an ever-present need for additional working capital.

Bridge loans can provide an effective means of generating capital in a hurry: in the case of a portfolio loan, they can mean the difference between being successful with a non-contingent offer for the purchase of residential real estate or not (among other things); in the case of a construction loan, they can provide needed seed money, which might otherwise be unavailable for building expansions and improvements; and, in the case of a business line of credit, they can mean the difference between providing short-term working capital or not, based on the ongoing needs of the business. Full-service banks, unlike most other financial service providers, can provide all these facilities almost seamlessly. From a client’s perspective, when the need for a bridge loan exists, and when a short-term problem can be overcome almost seamlessly to address such a need and produce a desired result, it truly is a beautiful thing.