There is a lot of confusion surrounding bridging loans and the whole concept of bridge financing. The misconceptions originate from the early days of bridge financing. In the past, bridging loans had a reputation for being too expensive, risky and a bit shady at times. But that’s not the case anymore. The finance industry has evolved enough that bridge loans are now fairly standard and everything about bridge financing is in plain black and white.
However, there is still a lot that even experienced entrepreneurs and investors don’t understand about bridge loans. This is a shame because, as you’ll find out, a bridging loan can be a vital financial lifeline for many businesses. It’s time to clear the air on what is a surprisingly simple financing solution.
How does a bridging loan work?
A bridging loan (or bridge loan) is a short-term loan used by companies and individuals to fill in a financial gap before securing a more permanent financial solution. As the name suggests, a bridging loan gives you a quick financial fix in between discontinuities in your regular income or funding streams.
In this case, ‘short-term’ can mean a couple of weeks or months – bridging loans typically span up to a year.
Most lenders offer bridging loans to commercial borrowers for investment or general expenditure purposes while waiting for a sale or payment. Depending on the situation, these loans are secured by real estate or inventory.
Bridging loans vs traditional loans
Bridging loans are often mistaken for business loans or other similarly structured mortgage loans. But unlike business loans, a bridging loan is a form of gap financing and doesn’t provide a long-term or permanent financial solution.
Typical business loans take a long time to process, approve and disburse. But since lenders understand that bridging loan borrowers need an urgent fix, these are usually processed as quickly — within a matter of days. Also, you don’t have to jump through hoops to get a bridging loan approved. However, in exchange for this convenience, bridging loans have a relatively high interest rate, additional fees and a short repayment period.
Is there an alternative to bridging loans?
Some entrepreneurs choose to explore alternative funding sources other than bridging loans when caught in a tight financial spot. Many try to stay away from the fees and high interest rates, especially when unsure about their financial future. There are some loan products and funding options that can give you a quick cash injection to cover running or investment costs in the interim period.
- Factoring loan — Factoring or equity lending means tying up loan repayments in the company’s receivables. For instance, you can take such a loan against unpaid invoices and share the proceeds with the lender as repayment.
- Liquidating or leveraging stock holdings — Selling shares is not a loan option and not always the best move to get funding. But rather than outright selling, some lenders offer quick business loans with stock value as collateral.
- Peer-to-peer lending — Some investors and communities form high-risk ‘lending clubs’ where start-ups and established businesses can source investment capital for potentially lucrative ventures. Peer-to-peer lending includes crowdfunding and some micro-lending programs.
- Merchant cash advance — This has a factor-rate fee structure where the lender grants you a sum of money and recoups it (plus interest) from your daily earnings or sales.
- Corporate credit card — A business credit card works in the same way as a personal credit card. Except it has a much higher cash-out limit and flexible reward and repayment programs.
There may be several alternatives to bridging loans, but they are not always available to all businesses. For instance, business credit cards are only awarded to firms with a long untarnished credit history with the lender. Plus, many of these quick financing options are quite predatory compared to bridging loans. Only a few loan products can match the convenience, availability and affordability of a bridging loan when you need instant financial aid.
Terms and types for bridge financing
Bridging loans are usually structured depending on the borrower’s situation. The loan period, principal amount and repayment terms may depend on when and how the borrower hopes to make the money back. However, the lender can set a fixed origination fee, maximum loan amount and interest rates based on various risk factors such as collateral value.
Generally, you can have a closed or open bridging loan. A closed bridging loan has a predetermined time frame agreed upon by both parties. It’s more appealing to lenders and has low interest rates and charges because the lender has a certain degree of certainty on the repayment schedule. With an open bridging loan, there is no fixed payoff date. This type of loan attracts higher charges and interests than a closed loan, and most lenders extract the interest upfront from the loan advance.
Bridging loans can be arranged in many different ways, but let’s look at the three most common structures:
- Debt bridge financing — This is the most popular structure of bridging loans. The borrower requests the loan and pays it back in cash after a short period.
- Equity bridge loan — Instead of incurring debt, some companies choose to give up equity shares in exchange for up to a year’s worth of financing.
- IPO bridge financing — In this case, the loan sees a company through an upcoming IPO, and the cash raised pays off the lender.
Most lenders prefer real estate as collateral. But how much equity do you need for a bridging loan? You must own at least 20% of the collateral property to secure a bridging loan. And the loan-to-value ratio typically ranges between 60%-75% for developed property and 50% to 65% for undeveloped land.
What are the risks of bridge financing?
Are bridging loans dangerous? The simple answer is ‘no.’ But loans inherently carry a certain degree of risk, and bridging loans are no exception.
If you take out a bridging loan to cover some investment cost or to provide working capital while awaiting a big sale, the greatest risk is the sale falling through. Even if you don’t make the anticipated sale, you’ll still be liable for the loan. Without proper planning or with a stroke of bad luck, you might end up accruing more liability than you expected.
If you have to borrow a bridging loan or any other loan for that matter, make sure you have a solid repayment plan or a fail-safe exit strategy.
When to apply for a bridging loan
There are two things you should understand before applying for a bridging loan. One, how much would a bridging loan cost? Two, what are the risks? If the benefits of bridge financing outweigh the cost and you have a sure repayment plan, then a bridging loan is right for you.
Many companies take out bridging loans to acquire huge investments or to keep operations going until the next paycheck. But you can also take a bridging loan to fund the completion of a construction project or to provide working capital in between credit tranches of a long-term business loan.
Do I qualify for a bridging loan?
Every lender has a unique set of criteria to qualify borrowers for various types of bridging loans. But generally, you have to tick the following boxes with most lenders to be eligible for bridge financing:
- Acceptable collateral with a high-enough value
- At least 25% ownership of the collateral
- Clear loan purpose
- Proof of revenue or turnover
- Business or company registration details
- Signed agreement with loan terms and conditions
How do you pay back a bridging loan?
You can pay back a bridging loan at any time within the agreed-upon loan period. The lender will not impose any fines for early payments as might be the case with some business loans or mortgages. If it’s a closed bridging loan, you have to pay back the full amount and interest on or before the designated deadline. An open bridging loan is a lot more flexible, but you risk incurring additional charges and higher interest rates by exceeding the allowable loan period (usually a year).
How quickly can I get a bridging loan?
Lenders usually take a few days to process a bridging loan application and release the funds. The time frame depends on the loan’s complexity. For instance, loan applications with multiple assets tied in as collateral and those asking for huge sums of money take longer to process. The lender may also understand your urgency and decide to fast-track your application.
How do I get a bridging loan?
Get a quick, hassle-free bridging loan from Aquamore today. We are a boutique lender, which allows us to process and disburse funds exceptionally fast. Our core mission is to help Australian businesses grow by realising their trade potential and objectives. This is why our loan products are structured in your favour. Loan advances start at $100,000 with a low 7% interest rate PA and only a 2.2% establishment fee. Apply now or contact us for a free, no-obligation quote.