In some instances, both individuals and companies need a temporary loan to tide them over until more permanent financing can be secured. These interim loans are known as bridge loans.
What Is a Bridge Loan?
A bridge loan is interim financing used by either an individual or a company for a period of time until they can secure permanent financing. These loans are short-term in nature.
A company that will be doing a round of equity financing in the near future might turn to a bridge loan in the interim to ensure they have sufficient cash to meet short-term operating needs for things like payroll, purchases, etc.
Individuals might need a bridge loan in connection with a real estate transaction. An example might be if you want to purchase a new home, but your old home has not yet sold. The bridge loan helps borrower "bridge" the gap between the time their old house sells and provide cash to buy the new home.
Bridge loans generally require collateral and carry relatively high interest rates.
How Does a Bridge Loan Work?
Businesses may use a bridge loan as part of the financing on a major expansion project to fill a funding gap until a more permanent type of financing is available. Projects might include the construction of new facility or a major acquisition. This might also be during a time period where the company is trying restructure its balance sheet to a more favorable capital mix. A bridge loan can also be used as interim financing for a company that is being acquired by another as a financial bridge until the acquisition is finalized.
Businesses will often need to look beyond their bank if they need the funds quickly as the process at their bank may take a number of weeks. Companies with a good credit rating and a solid balance sheet are the best candidates for these types of loans.
For individuals, bridge loans are usually connected with the purchase or construction of a new home while they still own their old home. The bridge loan gives the buyer help with any cash flow issues from having two mortgages for a period of time.
What Are the Pros and Cons of a Bridge Loan?
- A bridge loan can be a good source of temporary funds to get them through a financing gap, such as the period before they go through a new round of equity financing.
- Funding can be quick with certain lenders.
- Some commercial bridge loans may have prepayment incentives that can save the company money if they are able to pay off the loan early.
- Commercial bridge loans can be expensive both in terms of the interest rate plus fees such as origination fees and others that the lender might tack on.
- Even though these loans are short-term in nature, if the business hits a tough financial patch or the business deal falls through, the company can be stuck with additional high-cost debt on its balance sheet that it will need to refinance.
- A bridge loan can offer interim financing for individuals who are looking to buy a new home while still waiting for their existing residence to sell.
- Based on the structure of the payments, the borrower might be in line for a few months of free payments.
- This allows the home buyer to go ahead and purchase a new home without a contingency that they are first able to sell their old one.
- Bridge loans are generally an expensive way to borrow.
- The borrower must be able to qualify for this additional debt and must have acceptable collateral.
- They are still dealing with interest and payments on two loans, this can cause financial stress.
- If their old home doesn't sell, or if the economy suddenly tanks, they could find themselves saddled with more debt than they can handle.
How Do You Qualify for a Bridge Loan?
Bridge loans typically have a faster application and approval process than a more permanent business loan or a residential mortgage.
Bridge loans are not of one set type, so underwriting and qualification standards will vary. Businesses will generally need to put up assets such as real estate, equipment or other hard assets as collateral. Lenders will want to look at the business, including the circumstances of any special situation such as a new funding round or a pending acquisition to determine if the loan represents a good credit risk.
Individuals will typically need a solid credit score and a reasonable debt-to-equity ratio aside from the bridge loan. A typical bridge loan might be offered for 80% of the combined value of the two properties.
Bridge Loan Examples
Let's say a company has been approved for a long-term loan to finance their future growth and expansion for $2 million. However, the loan proceeds won't be available to the company for four months. They might get a bridge loan for part of this amount, perhaps $100,000, to cover any cash shortfalls for those four months.
An individual might use a bridge loan when searching for a new residence in a highly competitive market where sellers won't accept an offer with the contingency in which the buyer needs to sell their home first to qualify for or pay the new mortgage. The bridge loan provides the prospective home buyer with the necessary funds to continue paying, or pay off, their existing mortgage until their home sells, while taking on the additional debt of a new mortgage to buy their new home.
A bridge loan is a potential interim financing tool for businesses or individuals in certain situations. When considering a bridge loan, be sure to look at all aspects of the loan, as well as the short- and long-term implications and costs.
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