businessFinanceWhat is Bridge Financing, and How Does It Work?

February 14, 2023by nicoleevansmcda1

If a business needs quick and simple access to finance, bridge financing is a great choice. How does bridge financing operate, though?

In this article, we will discuss what bridge financing is and how it works.

What Is a Bridge Loan?

In order to fill a short-term liquidity shortfall, companies may use bridge finance. Businesses who need to finance a sizable acquisition or project that they can’t afford with their current cash flow frequently use bridge finance.

How Does Bridge Financing Work?

A corporation might not have all of the required finances on hand when it wants to grow or make a large investment. In such circumstances, they might look for bridging funding.

In collaboration with a bridging finance broker, the business will give the borrower a loan that is backed by current assets.

These assets can include: 

  • Real estate: This can include the equity in the borrower’s home, commercial property, or land.
  • Personal assets: These can include things like jewelry, art, or vehicles.
  • Business assets: This can include accounts receivable, inventory, or equipment.
  • Other collateralThis can include things like life insurance policies or patents.

The loan amount the borrower can receive will depend on the value of their assets. 

The company can utilize the money to pay for the expansion or investment once the loan has been approved.

The company will be able to pay back the loan after the project is finished and it is making money once more.

The loan often has a shorter term than standard loans—12 months or less—and a higher interest rate.

The following are important considerations for bridge financing:

  • Bridge financing is a type of short-term loan used to cover the gap between when a property is purchased and when long-term funding is secured.
  • Bridge loans are typically used when a property is being sold, and the proceeds from the sale will be used to purchase another property.
  • The loan allows the borrower to utilize the equity in the first property as collateral for the loan.
  • Bridge loans are typically interest-only loans, meaning that only the interest on the loan is paid during the term.
  • At the end of the loan term, the borrower must either repay the loan in full or refinance it into a permanent mortgage.
Bridge Financing

Bridge Loan Example

Let’s say you only have $200,000 in cash on hand and your company needs $500,000 to grow.

You might get a bridging loan for the remaining $300,000 from a lender. The loan would be secured by your current assets, and you would have a year to pay it back.

Although the loan’s interest rate would be greater than that of a conventional loan, it would provide you with the money you need to expand your company.

When Should You Use Bridge Financing?

When a company needs rapid and simple access to finance while waiting for long-term investment, bridge financing might be a great choice.

Some examples of when bridge financing may be a good option include:

  • You are in the process of selling your business but need cash to cover expenses in the meantime.
  • You are expanding your business and need capital to cover the costs of construction or inventory.
  • You need to make a large purchase but do not have the cash on hand to cover it.
  • You are waiting for a large contract to be paid out and need funding to cover expenses in the meantime.

Businesses who anticipate receiving money from another source soon but need access to finance in the interim may find bridge financing to be a great solution.

However, it’s crucial to keep in mind that bridge loans are frequently for a little period and have higher interest rates than conventional loans.

In light of this, the borrower should only utilize them if they are certain that they will be able to pay back the loan within the predetermined timeframe.

Weigh the advantages and disadvantages of a bridge loan and take all of your options into account before applying.

Pros Of Bridge Loans

Bridge loans are a great way to get access to capital quickly without going through the lengthy and often complicated process of applying for a traditional loan.

Other advantages of bridge loans include the following:

  • Bridge loans can be used for various purposes, including funding renovations, expansions, or even purchasing a new business.
  • They are typically shorter than traditional loans, so that you won’t be paying interest for as long.
  • You can make interest-only payments on a bridge loan, which can help to keep your monthly payments down.
  • They can be quickly approved and funded, which can be helpful in time-sensitive situations.

However, there are also some drawbacks to bridge loans that you should be aware of:

Cons Of Bridge Loans

For borrowers searching for short-term funding, bridge loans can be a great choice; however, there are several drawbacks to bridge loans that you should be aware of:

Here are some potential drawbacks to consider:

  • They typically have higher interest rates than traditional loans since they are considered a higher risk, which can add up quickly if the loan is not repaid promptly.
  • They have strict repayment terms, which can be challenging to meet if the borrower’s financial situation changes.
  • They typically require collateral, such as equity in your home or another piece of property.
  • They may have shorter repayment terms than traditional loans, which means you will need to repay the loan quickly.
  • Bridge loans are often unavailable from traditional lenders, making it challenging to find a reputable lender.

Before obtaining a bridge loan, borrowers should take all of these factors into account.

How Do You Qualify for a Bridge Loan?

There are some general requirements that the majority of lenders will look for, though the requirements for a bridge loan will vary from lender to lender.

  • Plan: Most importantly, when applying for any loan, borrowers should have a solid plan for how they will use the funds from the loan and repay the loan within the agreed-upon timeframe.
  • Stability: Borrowers should also have a good credit score and a steady source of income. You’ll need to prove that you have the income to make the payments on the loan. Which usually means providing tax returns and bank statements.
  • Equity: Some lenders may also require collateral, such as equity in your home or another piece of property. The equity you’ll need will depend on the lender, but it’s typically around 10-20%.

The lender will normally send you a check or wire the funds to your account within a few days of your loan application being approved.

After that, it’s up to you to decide how to use the funds to finish your project and settle your obligations.

In Conclusion

For businesses anticipating a short-term cash flow problem, bridge loans can be a useful financial tool.

Businesses can obtain the capital they require to pay expenses up until they start bringing in more money by using a portion of the equity in their current property.

Bridge loans can provide businesses with the flexibility and assurance they need to withstand a brief financial setback, even though they do carry some risks.

Do you have any advice for people looking into bridge financing? Tell us in the comments section below!

Contact MCDA CCG, Inc today if you have any questions about your business!

One comment

Leave a Reply

%d bloggers like this: