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If you’re looking for quick financial assistance to help you get by until you receive funding, you may consider a bridge loan. Bridge loans are short-term business funding solutions for borrowers and business owners awaiting other funds. If you’ve considered purchasing real estate or need help financing a project for your business, you may be wondering what a bridge loan is. This article will give you the bridge loan definition, help you understand how a bridge loan works, and determine when to consider bridge financing for your business.
What is a Bridge Loan?
A bridge loan, by definition, is a type of short-term loan for use in both personal and business financing to temporarily bridge gaps in capital (i.e. the period of time between needing financing and receiving it). It’s most commonly used in the event that you are looking to finance the purchase of real estate before you have sold your existing property. Bridge financing can help with the down payment, for example. However, there are also many other business uses for bridge loans as well.
By definition, bridge loans are short-term financing options with above-average interest rates that usually require you to put up an asset as collateral.
How Does a Bridge Loan Work?
So, how does a bridge loan work? This type of financing is secured through an application with a lender. It usually has a less stringent or rigorous approval process than a standard loan and boasts quicker funding once approved. The standard bridge financing term is less than one year.
When it’s time to apply for a bridge loan, check with your chosen lender to see if they are willing to offer you the financing you need. Your lender will review your financials and credit history before making an approval determination. Once approved, it’s off to closing where you can receive the funds necessary to help carry your business or project through until you receive other funding.
This funding may be used to:
- Cover the expenses of real estate transactions and property improvements, such as repairs and renovations
- Assist with business expansions or consolidations
- Fund purchase of inventory for seasonal businesses
As we touched on, this is essentially interim financing. This financing allows the borrower to have cash available while they secure permanent financing.
Bridge loan example
The most common bridge loan example is in personal or commercial real estate. When a business owner is looking to sell their existing property and purchase a new one, they may desire to use the accrued equity in their existing property as their down payment for the new one. But before the building is sold, that cash is not available.
To bridge that gap of time between the purchase of a new property and the sale of the old property, a borrower may use a bridge loan. Once the old property sells, the money from the sale will pay off the loan. Some borrowers, on the other hand, wrap the bridge loan amount into their total loan to pay back over the longer term.
Bridge financing for businesses
When using bridge financing for business funding, a common example is the need to finance a large purchase (like real estate or a piece of equipment). The down payment for that purchase may initially tie up cash that the business otherwise needs for operations. Without a steady stream of income or reliable accounts receivable, this can make large business expansion tricky.
In the event a business needs to make a large financed purchase, they can use this type of loan in the interim as cash to keep up with paying bills or payroll, for example. Then, once the larger financing goes through, the business can return to operating as usual.
Bridge Loan Rates
Bridge loan rates may vary depending on the amount borrowed, the duration of the loan, the borrower, and the use for the loan. A typical bridge loan rate will range between the standard prime rate and can get as high as 8.5% to 10.5% interest. For businesses, that rate can be as high as 24%. In addition, bridge loans typically have high origination fees (average is around 2%) in comparison to a standard loan. Finally, there are also separate closing costs, administrative fees, and legal fees. With all this considered, bridge loans can be a more expensive financing solution.
To understand the bridge loan rates that will apply in your situation, we recommend using a bridge loan calculator. You can find several bridge loan calculator options online.
The Pros and Cons of Bridge Loans
By definition, bridge loans work by acting as stopgaps. They are not supposed to be or able to be permanent or long-term financing solutions. So you may be wondering about the pros and cons of bridge loans in comparison to traditional loans. Let’s weigh in on that next:
There are several advantages associated with bridge loans. These include:
- Faster Access to Funds. Bridge financing is available quickly once your application is approved. It can help you access funds within just a few days or weeks, making it an ideal option for those in need of fast funding. You may also be able to receive bridge financing at more lenient terms than what you might eventually receive from other lenders.
- Easier to Qualify for. Since they are typically accessed through your business’ personal credit score and financials, bridge financing tends to be easier to qualify for than a traditional loan. You can generally apply with a lower credit score than you need for a traditional loan. This means your chances of being approved are higher, so you may be able to access the funds you need for your business sooner.
- Lower Rates Than Other Loans. These loans have higher rates than other financing options because they are short-term in nature. However, compared to other types of loans with longer payment terms, they can still save you money with competitive interest rates. You may pay less in interest over time than what you might expect to pay elsewhere.
In exchange for the obvious benefits of convenience that a bridge loan offers, there are also some cons to consider:
- High interest rates. Rates can be twice as high as a traditional loan because of the immediate nature of this funding. That’s why it’s important to make sure this type of financing is best for your business before applying.
- One-time use. The funding you receive through this type of financing can only be used one time.
- Short term loan duration. These loans can offer quick access to capital, but also come with some restrictions. Because they are short-term loans, they require frequent interest payments and may be difficult to renew if the funding isn’t used on time.
- Large fees for processing. A lender may charge you higher fees for processing this type of loan.
But typically, the need for convenient, quick, and easy to access cash outweighs the cons/risks for most borrowers.
Alternatives to Bridge Loan Financing
While bridge financing may be an attractive solution for quick financing, it is not always necessary to secure a bridge loan to get access to quick capital. Let’s explore some alternative asset-based lending options:
Home equity loans
Home equity loans also allow you to borrow against existing assets. The major difference between a home equity loan and a bridge loan is the term duration. You can take out a home equity loan for a period of up to 20 years and it will typically have a more favorable interest rate.
Home equity line of credit (HELOC)
A home equity line of credit is essentially a second mortgage on your house. It is a low-interest way to borrow against your home to finance a new project. One of the biggest benefits of owning a home is the ability to build equity and use it. A HELOC is one avenue that makes this possible without selling your home.
Business term loans
Finally, you may be able to borrow money using a personal or standard business term loan. You will need to have a strong credit history, proof of income, and other financial documents. You may even need to put up collateral. The exact terms of these loans vary widely.
Is a Bridge Loan a Good Idea?
Now you know what bridge financing is, how it works, and typical bridge loan rates with a bit more confidence. But now that you understand what a bridge loan is by definition, you may still have questions. The main one being, is it a good idea?
The answer to that question can depend on your circumstance. These loans are typically for borrowers who are in sudden or time-sensitive need of capital. Someone who has an immediate need for a lot of cash without a lot of red tape (such as a business looking to fund the quick replacement of broken equipment) may benefit from bridge financing.
If, on the other hand, you have the benefit of time or enough capital to bridge the gap between now and a future funding date, this type of funding may not be a good solution.