Lending & Finance

 

04 24 2017

What are bridge loans, and how do they work

04 24 2017

What are Small Business Bridge Loans and How Do They Work?

As every entrepreneur knows, starting or growing a business requires capital. Equipment, supplies and space all cost money, and are all required to getting the company going.

Business owners have several options to purchase or rent necessary items. Some people are able to save up enough funds to cover initial costs, while others seek out financing.

While savings and financing are excellent options, there can be several complications with these plans. This is where bridge loans come in. When traditional financing obstacles prevent a business from moving forward, a short-term loan may be enough to make the connection between today’s needs and tomorrow’s funds.

Common roadblocks with traditional financing

 

Waiting period

Securing long-term financing can feel like a weight off your shoulders, but there is one caveat: There’s often a period of time between confirming these funds and actually acquiring them when you’re stuck waiting. Without the funds, it’s difficult to move forward. And even though you know the money is on its way, it doesn’t help the fact that cash is needed now.

Work in progress

There are often certain requirements for securing a mortgage for a commercial property. The building must be up to code and safe to work in. However, not all buildings meet a lender’s requirements. But if it’s in the perfect location, has the right dimensions or other features or is at the right price, it can be hard to pass up. In this situation, you might resolve to fix up the building, then secure a mortgage. The only problem is, renovating a commercial building is an expensive endeavor. Short-term financing will probably be required.

Low credit

Lenders look carefully at a potential borrower’s financial history to determine whether loaning funds to the person is risky or not. If you have a low personal credit score, the lender may be wary to issue a loan. As such, for low-credit business owners, finding affordable financing can be a major challenge.

Getting funds quickly

Each of these frustrating situations is easily resolved with a bridge loan. A bridge loan is short-term financing that will bridge the gap, so to speak, between your current need for funds and your future long-term financing plans. Not every lender offers bridge loans, but it’s not hard to find an alternative lender that does.

What makes bridge loans unique

Typically, bridge loans have payback periods of between 6 months and 3 years, according to Fit Small Business. At that point, you’ll probably either have the loan paid off or will refinance it with a longer term loan.

Given the nature of bridge loans – granted quickly when long-term financial solutions aren’t feasible or available – creditors view these investments as riskier than other loan products. As such, they typically come along with higher interest rates. Credit Sesame noted that borrowers can expect to pay rates around 2 percentage points higher than a typical long-term fixed-rate loan.

Requirements for obtaining a bridge loan

Sometimes, lenders will have credit score minimums for bridge loans. Other times, a creditor might require a specific debt-to-income ratio. In general, though, there aren’t many guidelines that are set in stone. While a higher credit score and a lower DTI would be beneficial, not having these attributes isn’t necessarily a deal breaker.

Many lenders will want to inspect your debt service coverage ratio before determining whether to grant you a bridge loan, and at what rate. Your DSCR demonstrates the net operating income of the property for which you’re getting the loan. For example, if the property is an apartment building, the DSCR will include:

  • Income made through rent.
  • Property tax expenses.
  • Insurance expenses.
  • Utilities expenses.
  • Repairs and maintenance expenses.

The DSCR must show that you can cover 100 percent of the loan payments, and lenders will typically want to see a little bit extra. The ideal DSCR is 110 percent of the bridge loan or more.

Since bridge loans are typically procured as a short-term solution while waiting on a longer term loan, lenders might ask about your plans for financing later on. Some might want to see evidence that you do have additional funds on the way. Or, they might want to see proof of a solid payback plan. Fit Small Business pointed out that, if you’re experienced in the industry for which you’re procuring funds, supplying your resume and elaborating on your previous successes can help in obtaining the loan.

As an entrepreneur, you know that available working capital is necessary to get your business started and keep it moving forward. However, there are sometimes when funds seem to be just out of reach. In those moments, a bridge loan can be a short-term solution that will give you long-term results.

 

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