Why should a business owner take out a bridge loan?
Bridge loan uses
- For interim financing while waiting for a long-term bank loan
- Pay property, utility or payroll taxes
- Cover expansion costs such as leasing a larger building or hiring more employees
- Make inventory and vendor payments
- Cover seasonally slow periods
You might be a successful restaurant owner who is looking to open a second location, or you might be running a technology-based startup company that’s six months away from having a new, highly profitable product. In either case, if you don’t have enough cash on hand and don’t qualify for a traditional bank loan, where do you get the money you need?
A commercial bridge loan could be an option. It is a short-term loan that essentially bridges the gap between long-term financing and your business’s next infusion of capital.
Before approaching a lender, it’s important to understand the difference between bridge loans and hard money business loans, which are similar products that are often confused for each other. Here are some basic differences:
- Collateral. Like a hard money loan, a bridge loan is usually backed by some form of collateral, such as property or inventory, but hard money lenders tend to focus far more on the collateral’s value than other credit or financial factors.
- Credit. A bridge lender will likely require a higher FICO credit score and a longer application-processing period, but will offer a lower interest rate and a higher loan-to-value (LTV) ratio than a typical hard money lender.
- Construction. A bridge loan can be used for renovating an existing building, but may not be suitable for new construction, unlike hard money. Some bridge lenders, in fact, specifically prohibit loans for ground-up construction projects.
Once you comprehend the differences between these types of loans, you can decide whether a commercial bridge loan is the best solution for your business’s financial needs.
Banks, credit unions and other traditional lending institutions often have lengthy application processes that can spell trouble for a business that needs a quick influx of cash. Even if the business owner is eventually approved for a portfolio loan or funding from the U.S. Small Business Administration (SBA), the owner may need money in the interim.
Bridge loans can be used for many purposes — property, utility or payroll taxes; expansion costs, such as leasing a larger building or hiring more employees; inventory and vendor payments; and operational costs for seasonal businesses that have revenue declines.
Bridge loans are often used for residential purposes when a person buys a new home and needs temporary financing for the mortgage payments while waiting for their old home to sell. It works the same for commercial properties. A business owner may have qualified for permanent financing on a new property, but can’t keep pace with operational expenses until their existing property sells. Or they may be keeping an existing property and need a bridge loan until a new property begins to cash flow.
Features and requirements
Compared with long-term loans that have repayment terms of 10, 20 or even 30 years, bridge loans are much shorter in duration. They usually have to be repaid within three to 18 months, although some lenders will stretch their terms to five years or more on larger balances of $1 million and up.
Interest rates on bridge loans vary and may be fixed, adjustable or feature a hybrid structure. The rates often range from 8 percent to 20 percent, but can be much higher for specific loan types. And they can be repaid in installments or through a single balloon payment at the end of the term. Most bridge loans do not have prepayment penalties, meaning a business owner can pay off the entire amount at any time.
Bridge loans are commonly nonrecourse loans, meaning the lender can only seize pledged collateral and cannot seek other assets if the borrower defaults. Bridge loans are available on a wide variety of property types, including offices, retail outlets, industrial properties, apartments, mixed-use buildings and mobile-home parks.
New businesses that have yet to establish cash flow or build any equity may be ineligible. Bridge lenders often require a business to be operational for six months to a year. They may also require a property appraisal.