What is a Bridge Loan? Everything You Need to Know
A vital part of being able to run a successful business is borrowing money. Sometimes, the funds aren’t available when they’re needed. What options do you have and what is a bridge loan?
A bridge loan can provide you with financial relief to keep your business strategy on track. This article will help you learn more about this type of a short-term loan.
What is a Bridge Loan?
A bridge loan is a temporary loan designed to float a company between financing. The terms are usually short, such as one or two years.
Companies will receive a lump sum of money from the lender. In return, they’ll make monthly payments with interest until the loan is paid.
There are three qualifiers for a company to be eligible for a bridge loan:
- Loan-to-value (LTV) ratio: LTV is the value of the loan compared to the need
- Current equity: Most lenders will only bridge up to 80% LTV so a business will need 20% equity
- Debt-to-income (DTI) ratio: Divide total monthly debt payments by gross monthly revenue
A good example is if a large company is trying to secure a bridge loan to purchase a smaller company for $100 million. They can only produce $20 million so they go to a lender for $80 million.
The lender is okay with this amount because the business has current equity of 20% and the LTV is 80%.
The larger company is able to purchase the smaller company in this example. They’ll be required to pay back the loan, but will be able to use assets and revenue streams from the new company for this purpose.
How do Bridge Loans Differ From Traditional Loans?
There are a couple of differences between bridge loans and traditional loans. Bridge loans are a short-term options and can be refinanced after you secure new funding. If you find new financing two months after you start a bridge loan, you can adjust the payments to a long-term option.
Most people will want to pay off the loan as soon as possible to avoid fees. Bridge loans are also quicker than traditional loans in every facet. Traditional loans for a mortgage can take weeks to process and disperse.
Bridge loans are generally processed and released within a week, and the payments you make could be delayed three to six months. Don’t forget that when you do start making payments, there will be interest attached to the amount.
What are the Pros and Cons?
As a business owner, you’ll have to decide if a bridge loan meets your needs and standards. Consider the following lists of pros and cons to determine if these loans are right for you.
- Quick: Unlike home loans, bridge loans are usually accessible to your business within a business week
- Repayment options: Each lender will have different options that can make a financial gap easier for you
- Short term: The loans are designed to be paid off within a couple of years at the most, leaving you with a robust free cash flow sooner than later
- High interest: Bridge loans are known to have high interest rates due to their short length
- Risky: If your future financing falls through, you could be stuck paying off a loan with high interest and fees
- Difficulty: Lenders don’t give bridge loans to just anyone
A bridge loan might seem like a quick cash option, but the high interest rates and risk might have you recalculating your need.
Many lending institutions will require you to post collateral against the loan. This might be an important asset, such as a piece of machinery or property.
Defaulting on the loan can result in the forfeiture of the collateral.
Look at the Fees
It can be easy to look at the amount you need for your business without considering any of the fees associated with obtaining the bridge loan.
With the equity you have available, set some aside to help close the loan. Here are some of the fees you might pay:
- Loan origination fee
- Title policy
- Wiring fee
- Escrow fee
- Notary fee
- Administrative fee
- Appraisal fee
Each lender will have different fees and interest rates according to the amount of money you need. The total cost of closing can run between 1.5% and 3.0% of the loan amount.
Interest rates for a bridge loan can run high. Current mortgage rates are between 3.5% and 5.5%, depending on if there are programs available.
Bridge loan interest rates are tabulated by using the prime lending percentage and adding 1% or 2% to the number. Since the prime lending percentage is set by the Federal Reserve System, it can change monthly, making your payments different every month.
Where Can I Get a Bridge Loan?
Most of your local banks and credit unions offer bridge loans, but the requirements and qualifications to get a loan can be rigorous. Many banks require you to have done previous business with them to even apply for a bridge loan.
Online bridge loan services can offer quick and easy access without going through mountains of paperwork. Save yourself the headache and stress of being denied when there are online sources to assist you.
If you don’t think bridge financing is right for your business, there might be other types of business loans available.
Check out these alternative funding options:
- SBA loans
- Business line of credit
- Borrow against equity
- Use your accounts receivable to secure a loan
The Small Business Administration (SBA) provides loans for businesses that need capital. Their criteria for the loan varies from your traditional bank. The interest rates are competitive and the terms are favorable.
A business line of credit is another alternative source. Many lenders will offer up to $100,000 in return for higher interest rates.
A company can always trade equity for capital to fund projects or purchase assets. Many business owners are attracted to this option because there is no cash being sacrificed.
Are Bridge Loans Right for My Business?
A bridge loan can provide a lifeboat for your business until it reaches safer financial shores.
If you’re ready to secure the financial future of your business, then contact us so we can get the working capital you need.