What is a bridge loan?
A bridge loan is one in which a person or small business can have cash in-hand quickly (usually within hours) while waiting for another source of funding. These loans “bridge” the funding gap between the money that you need and a longer-term loan solution, which usually have a longer application and approval period.
As your business experiences growth and expansion, opportunities may arise when you have to make a time-sensitive purchase and not have the funding to do so. For example, if you have the chance to buy a large, very expensive piece of equipment that you need at a discounted price, you can use a bridge loan to buy the equipment before securing a long-term funding option with a lower interest rate. Or if you have the opportunity to purchase or lease a new piece of real estate but don’t have the time to wait for the mortgage loan process, you may consider a bridge loan. Perhaps a business has a series of investors bringing capital to the business but the cash capital won’t be available for immediate financial needs – this is another example of a reason some businesses apply for bridge loans.
Here is a list of a few of the most common reasons that businesses apply for a bridge loan:
- Payroll expenses
- Late payments from customers (anticipated so not written off yet)
- Opportunity for unexpected expansion (i.e. real estate purchase or strategic acquisition/partnership)
- Inventory discount opportunity, past due vendor payments, or unexpected increase in demand for your product
- Seasonal or unplanned business lull
- Buy-time for anticipated investor capital or long-term financing options
- Natural Disasters (i.e. SBA helping businesses affected by the California Wildfires)
Keep reading, however, because bridge loans are available so quickly – it is very important that you are clear on the terms, understand they often have higher interest rates, and you should have a plan to pay back the loan before it snowballs beyond your control.
How do bridge loans work?
Bridge loans are short-term loans that can vary in length from less than 1 month to over 24 months. Bridge loans can be structured differently – perhaps it’s a few payments, or a lump sum in the beginning and at the end. Amounts can vary from a few thousand to several thousand dollars, but they all carry a little higher interest rate (anywhere from 9% to 29%), than the ‘traditional’ long-term loan.
As always, it is best practice to do some research and talk to a few different companies, as choosing a bridge loan provider for your specific needs is crucial in making this a wise business choice. Let the lenders know what your time frame is for repayment, and ask about pre-payment penalties should you choose to pay the loan off earlier than anticipated. Both of these factors will not only affect your interest rates and monthly payment amount, but will also affect whether or not you get approved for the loan. The lenders’ support teams will help you figure out how to best structure the loan for your needs, especially for new businesses and/or for first time bridge loan applicants. Don’t forget: bridge loans are common across all industries, so be honest about why the money is needed. Your loan officer has probably heard it all and can help advise you on the best course of action for your needs.
Bridge loans also often require collateral, such as an interest in specific inventory or equipment. Be prepared to provide documentation for such items as requested by the lender, and, if necessary, have an attorney go over any documents that you might have questions about regarding items being considered as collateral.
What are the advantages of bridge loans?
The greatest advantage of a bridge loan is the quick payout to the borrower. You can often have cash-in-hand within hours of the lender receiving your application. The loan application can usually be filled out online, and there is less paperwork required than with a traditional loan.
Another advantage of bridge loans is that you might be able to structure repayment in a way where the loan is paid off when you secure the long-term financing option. Interest will still be accruing, however, so the payoff amount may be greater in this case.
Just remember that these advantages come at a price… while the benefit may be worth it, do your due diligence and read the terms carefully – especially if you are borrowing from a lender that is new to you.
If you’re a small business owner and are interested in more information on a commercial bridge loan while you’re waiting for a transaction to close, contact one of the experts at LoanMe to learn more.