How Do Bridge Loans Work?

Bridge loans are short-term financing that allows borrowers to meet their current obligations by providing them immediate cash flow.  While they come with high-interest rates and short repayment period (usually just one year, although some carry a two-year repayment schedule), in certain situations they are more ideal than other business loans.

Also, bridge loans require some type of collateral, which can be in the form of property, inventory, accounts receivables and cash-equivalents, stocks, bonds, future paychecks, among many others.  Meanwhile, the usual loan-to-value ratio is 50-70 percent.

Basically, bridge loans “bridge the gap” during financial difficulties or in the event of insufficient cash flow.  Oftentimes, entrepreneurs turn to them when they are waiting for long-term financing that comes with lower interest rate and other more favorable terms.

The Purpose of Bridge Loans in Business

If you’re going to expand your business, you may need some type of financing.  Bridge loans can help you cover the change in overhead and the increasing operational cost while you wait for a more secured, more permanent long-term financing.

Aside from business expansion, securing bridge loans also makes sense when you purchase another business or merge with another company.  This type of financing covers the gaps while you look for a more permanent solution.

This temporary financing also makes sense when you need to purchase large inventories before the peak season.  Seasonal businesses–e.g., consumer goods, electronic devices, food distribution, and e-commerce–regularly encounter an unusual surge of demand, which they should be able to meet by buying more inventories.

Bridge Loans in Real Estate Investing

Bridge loans are also common in real estate investing.  They are particularly suitable for buyers with an existing home who wants to purchase a new residence.  However, it only works if you are absolutely certain that your current house will sell and so it makes sense to consult with a trusted advisor before resorting to this type of funding.

Compared to home equity loans, bridge loans carry higher interest rate (usually 8-12 percent).  However, it comes with one notable advantage: It avoids contingent offers and so the buyer’s move-up offer seems more attractive to a seller.

Contingency offers may spook some sellers because the buyers may not be able to purchase a new home without first selling their current property.

In the event that the buyer has made a contingent offer and the seller has issued a notice to perform, the buyer can still move forward with the purchase by simply removing the contingency to sell.

How Bridge Loans Actually Work in Real Estate

For a short period of time, the borrowers will own two homes.  With bridge loans, they can close the move-up home purchase before they sell their current residence.

Simply put, this financing option allows you to put your existing residence on the market without having to worry about restrictions.  After all, most lenders of permanent, long-term loans stay away from borrowers whose property is listed on the market.

Furthermore, most bridge loans do not require a monthly payment for a few months (or an average of four months).

Another benefit of bridge loans: Most of them do not come with re-payment penalties.

Minimize Your Risks-Know What You’re Getting Into

Any type of financing has its pros and cons.  For this reason, smart borrowers will spend time learning and understanding the best option that will provide them the most benefits and the lowest level of risks.

Business loans that act as bridge loans typically come with a 3-24 month repayment schedule, whereas loans that are geared towards house flippers and real estate investors often come with a one-year schedule.

Another way to minimize the risk is to understand the terms and conditions.  Aside from the higher interest rate (compared with permanent business loans), take note that bridge loans come with multiple fees to cover administration, title policy, recording, drawing, appraisal, and loan originating.

Bottom Line

The fast application makes bridge loans appealing to people who need quick access to funding.  Nonetheless, you should only see them as a temporary solution, much like a bridge to close the financial gap you’re experiencing in the meantime.

Bridge loans are only ideal if you plan to pay it off with more permanent loans with lower interest and longer repayment schedule.

A bridge loan is just one of the growing number of alternative financing options available today. In the past, commercial banks, which are known for their strict lending rules, were the only source of business loans that provided high leverage.

Before you resort to any type of business loans, make sure that you understand the terms and conditions and their core purpose to your business.

For more information about business loans and bridge loans, contact the professionals at AS-IS loans. We only provide approvals. Call today to learn more!