What is a Bridge Loan?

In the world of business, you will have noticed that all sorts of financing options exist to help in the short-term, medium-term, and long-term. Today, we’re looking at a short-term option available to both businesses and those looking to buy a house. You’re going to discover what a bridge loan is, how it works, the pros and cons of the financing option, and a whole lot more.

What’s a Bridge Loan?

Of course, the natural starting point is a definition. Whether you’ve seen a bridge loan mentioned online or it has been suggested by a business friend, you need to know what it means. Like a physical bridge connecting two pieces of land, a bridge loan is designed to provide individuals or businesses with funds between two points in their financial landscapes.

For example, bridge financing for home buyers is used to purchase a property before their current property has been sold. Although it comes with risks - risks that we’ll explore in this guide - it means that the buyer can put a down payment on a home even before selling their existing property. Sadly, thousands of people miss out on their dream home every year because of a delay somewhere in the selling process. A bridge loan is a simple way to navigate this problem; the idea is that the buyer pays off the loan once the sale has been finalized.

Meanwhile, a bridge loan in business is essentially used for the same purpose. It’s a way to obtain finance in the short term to bridge the gap before removing an obligation or securing a more permanent source of finance. Businesses often use bridge loans to meet payroll demands, make a tax lien payment, or even for purchasing inventory.

Knowing that income is just around the corner is a helpless feeling; unfortunately, you can’t pay staff or suppliers with promises. Consequently, you can fill this gap with a bridge loan and then repay the loan once the permanent source of finance is available.

How Does a Bridge Loan Work?

As a form of alternative financing, lenders customize the loan based on the situation of the individual or business. As mentioned previously, this could be to make a down payment on a property, make a tax lien payment, or for another purpose. The key point is that the loan is short-term and typically paid back within one year.

Not only is bridge financing used by individuals and growing businesses, but it’s also actually used by some of the biggest companies in the world. Back in 2016, Olayan America Corporation wanted to buy the Sony Building. However, it didn’t have the capital at the time. Therefore, ING Capital provided bridge financing and Olayan had more time to secure a permanent source of finance (while also securing the Sony Building).

Sometimes, a business runs low on cash and they need to cover short-term expenses while waiting for a more permanent form to arrive. As an example, it might be that you’re waiting for a round of equity financing to close. Although the promise of cash is exciting, it doesn’t help you to meet short-term expenses. This type of situation is exactly why bridge loans were introduced to the market; you have working capital to pay expenses while the funding goes through the necessary steps.

Over the years, many variations of bridge loans have arisen in the industry. For example, those who flip properties will know the difficulties that come with cash flow from time to time. With a fix-and-flip bridge loan, you can pay for the next project before selling the existing one. In a world where fluidity is essential, this could be the difference between moving onto the next project smoothly and having to wait several months.

 

Rates and Purposes of a Bridge Loan

Ultimately, the rates you receive for bridge financing all depend on the type of loan you seek as well as the facility from which you take the loan. While researching, we recommend checking out the alternative funding methods available at the South Florida Funding Group. They have extensive experience and solutions to help businesses of all sizes (as well as individuals!).

Generally speaking, interest rates sit between 8% and 20%. In terms of purpose, you can get bridge financing for a whole manner of reasons. Individuals mostly use this type of alternative funding to make a down payment on a new home while waiting for their existing home to sell.

On the other hand, businesses have more reasons to try bridge financing. This includes:

• Meeting payroll demands
• Purchasing inventory
• Making a tax lien payment
• Paying suppliers

As mentioned, the market is full of bridge financing solutions, so choose the one that matches your needs. As well as alternative funding solutions, like that at the South Florida Funding Group, you may also find bridge financing available at traditional banks, community banks, small banks, and credit unions.

Benefits of Bridge Loans

Why should you choose bridge financing as an individual or as a business? Here are some of the most attractive benefits.

Fast Approval - Firstly, bridge loans tend to be more accessible than more traditional forms of financing. Perhaps you’re actually waiting for traditional financing and this is why you need a short-term loan to cover expenses. Depending on the method you choose, some businesses obtain financing in three to ten days. As long as you’ve been in business for over six months, your purpose doesn’t necessarily matter, and your industry also isn’t important.

Flexible Repayment - Another benefit of a bridge loan is that you can normally repay the loan in a way that suits you. After the permanent source of finance arrives, you might decide to settle the balance of the bridge loan entirely. Otherwise, most lenders allow you to split the payment as you wish. While some want to pay an amount per month, others will pay weekly or even daily.

Access to Funds - Of course, one of the biggest benefits is that you get access to funds when you need them most. While a homeowner can remove the contingency to sell from their offer on a property, businesses have money to deal with short-term expenses just when everything starts to look bleak. Just because a source of permanent finance is on the way, this doesn’t help when you open the office door to find yet another bill on the welcome mat.

Fortunately, bridge loans help in this situation and they have the potential to keep a small business operating during difficult times. Rather than closing your doors, get a bridge loan and receive the finance you need to continue operating while waiting for a more permanent source.

No Instant Repayment - With some bridge loans, you may not need to start repaying instantly. For example, the lender may offer a few months with no repayments. Not only do you get much-needed funds for the business, but you also get a few months of freedom with this money. With other sources of finance, you’re often forced into repaying the money immediately.

Secured with Real Estate - Newer businesses and those with poor credit scores may worry about their ability to claim a bridge loan, but this doesn’t necessarily need to be a concern. Why? Because some businesses can secure the loan with real estate. Naturally, this presents a higher risk if you can’t make the repayments in the future. Therefore, we only recommend securing against your real estate if you’re sure of long-term financing.

As a source of alternative funding, bridge financing is a strong option, and the ability to secure with real estate opens the door to many businesses. You don’t have to worry about the company history, your personal credit score, or other matters of this nature.

Simple Terms - When all is said and done, the terms of a bridge loan are also incredibly simple in most cases. Since it’s a short-term form of alternative funding, the idea is that you’ll borrow an amount of money to bridge the gap before a more permanent solution comes. The credit requirement is minimal if you have collateral (as discussed in the previous point), repayment is flexible, and approval is quick.

Drawbacks to Bridge Loans

In the interest of proving you with all the information you need to make a sensible decision, we want to also discuss the drawbacks of a bridge loan. You might decide that another alternative funding option from the South Florida Funding Group is better than a bridge loan, for example.

Higher Interest Rates - Compared to other sources of finance, you will find that bridge loans come with higher interest rates; this can come as quite a shock if you aren’t aware or prepared. Before signing any loan, make sure you understand the terms, the interest rates, and what you’re expected to pay back.

Higher Fees - Additionally, choose the wrong lender and you’ll be left with all sorts of fees too. For the best rates and fees, we recommend working with the South Florida Funding Group. Whether it’s with bridge financing or another form of alternative funding, we have something to help every situation.

When applying for a bridge loan, the fees are determined by the lender (as well as the size of the loan itself!). While some charge an appraisal fee, others also charge an administration fee for the loan. Even after this, look out for title policy fees, escrow fees, wiring fees, and other fees with real estate loans.

Short Terms - Of course, this is a source of financing designed to get you between two points in time. Generally speaking, the longest term you’ll find for a bridge loan is one year, and this is because it’s assumed that you’ll access a more permanent source of finance soon. If you need a longer loan, you’ll need to look at other methods. For instance, this could be SBA business loans, unsecured or secured business loans, a merchant cash advance, equipment financing and leasing, or an unsecured business line of credit.

If you have long-term financing arranged, the fact that bridge loans are short-term shouldn’t cause any problems.

Collateral Requirement - In many cases, the lender will ask for some form of collateral, and this is normally real estate or another company asset. With very few credit checks, and no reliance on credit to secure the loan, the lender needs security just in case you can’t pay the loan back within the agreed time. If you don’t have long-term finance secured, be careful with bridge loans because the last thing you want is to lose real estate or other company assets.

Liens Searches - As a continuation of the previous point, the lender may require liens searches on the collateral. Essentially, this ensures that no third party has a right to the property and that the lender will have access should something go wrong with the loan itself.

Traditional Loans vs Bridge Loans

With this, you’re now learning more about bridge loans and how they can help businesses as well as prospective homeowners. However, we know that you’re likely to be researching a variety of funding solutions. Therefore, it’s important to understand the main differences between bridge loans and traditional loans. In truth, they both have benefits and drawbacks, so choosing the right solution depends on your circumstances and needs.

With bridge loans, the benefits are that the terms are often simple, you get flexible repayment options, the application is fast, and you can secure the loan with collateral. However, the drawbacks include the short-term nature of the loan, potential fees, and higher interest rates. Therefore, you’re almost paying the price for the convenience of a faster application and approval.

On the other hand, traditional loans have lower interest rates, fewer fees, and are available for a longer period. But the application process is slow, repayment is normally over a longer period, and you don’t get the same levels of convenience.

The reason why most borrowers accept the higher interest rates with bridge loans is that they have plans to repay the loan quickly (and because they need access to funds quickly!). Eventually, they plan to replace the high-interest, short-term loan with a low-interest, long-term loan.

Bridge Loans in Real Estate

Throughout this guide, we’ve focused quite heavily on bridge loans in the business world. Therefore, you know that it helps to meet short-term business expenses. This includes purchasing inventory, meeting payroll demands, and making tax lien payments. However, bridge loans are also incredibly popular with home buyers.

Despite working essentially in the same way, bridge loans in the real estate world are slightly different. For example, lenders don’t always have a minimum requirement for debt-to-income ratio or FICO scores. Instead, they tend to offer the loans in situations where it makes sense to do so. If the homeowner is pushing to buy a new home and is likely to sell their existing home within the terms of the bridge loan, it makes sense to lend the borrower the money.

With this funding, the buyer can purchase the new home while still trying to sell their existing property. One of the biggest benefits of this process is that buyers can get their dream home without worrying about selling their existing one first. As mentioned previously, many buyers have missed out on dream homes because of a problem in the selling process. With buying no longer reliant on selling, there’s more freedom of movement, and the whole real estate industry has a new fluidity to it.

Another reason to choose a bridge loan as a buyer is that you won’t need to make monthly payments in the first portion of the loan. These days, lenders understand the flexibility required when buying and selling. Therefore, they don’t ask for repayment until some way into the contract.

Sadly, the drawbacks to the bridge loan for homebuyers remain just the same as we saw for businesses. For one thing, this means higher interest rates compared to home equity loans. Additionally, buyers are left paying for two mortgages while also accumulating interest on the bridge loan, and this can lead to stress. The sooner you sell, the sooner you can rid yourself of one mortgage and start paying off the bridge loan.

Summary

All in all, bridge financing is a brilliant solution for businesses and homeowners looking to fill a short-term void. As the name suggests, it’s a solution that allows businesses to meet short-term demands while waiting for long-term financing. Similarly, homeowners can sign the contract on their dream home without being held back by a difficult selling process.