How Bridge Loan Financing Works

Bridge loans are useful during times when financing is needed but not yet available. With a bridge loan, you can borrow up to 80% of your property’s value.

Depending on the lender’s terms, you may make interest-only monthly payments. You can also make no payments until the property is sold or fixed monthly payments.

Both corporations and individuals use bridge loans for many different situations. Companies need considerable funds to boost their operations.
Bridge loans can help to make major business upgrades. 

This can be done by financing commercial property renovations, acquiring a new office, or moving to a more favorable business location.

A homeowner can purchase a new home with the loan while they wait for their current home to sell. Borrowers use equity in their current home for down payment on the purchase of a new home.

Most bridge loan lenders won't go above an 80% loan-to-value ratio. You may also have to pay escrow and title fees. You will need to have at least 20% equity in your current home for a bridge loan to be an option. 

Lenders also vary when it comes to fees, but you will pay an origination fee. A bridge loan as a short-term financing option has drawbacks. Some loans also have a prepayment penalty.

How do bridge loans work, and who can qualify? What are the advantages and disadvantages of this type of short-term financing?   

What is a bridge loan?

A bridge loan is a short-term loan used to buy assets or cover cash flow obligations until longer-term financing is secured. The loans are short term, up to one year. Some lenders offer terms ranging from a few months to five years. 

The lenders expect more frequent payments sometimes daily or weekly. They have relatively high interest rates, and are usually backed by some form of collateral such as real estate or inventory.

This is a type of funding that many small businesses use to satisfy immediate cash flow needs. The loans are quick and easier to secure than traditional loans. They are also more expensive.

If you are looking for quick financing without the taxing approval process, a bridge loan may work for you. Borrowers who cannot qualify for conventional mortgages may also apply for these loans. A bridge loan may be used in real estate transactions.

The maximum amount you can borrow with a bridge loan is 80% of the combined value of your current home and the home you want to purchase. Lenders have different standards.

Businesses can also use inventory or other assets as collateral for a bridge loan. The loan can be used to buy additional inventory or make repairs before meeting their sales goals.  

What to look for in a bridge loan

It can be difficult to decide which type of bridge loan is right for you. It is important to know what key features to look for in any bridge loan.

Short-term loans have higher interest rates than long-term loans. Lenders must take into account risk when agreeing to loan out money. 

Look for a bridge loan that offers an interest rate that you can handle. It is a good idea to look into any extra fees that a lender may charge. 

Take the time to figure out how much extra you will be paying over the course of the payment period.

If this amount exceeds what you expect to earn, it may be better to look elsewhere for a loan. Look for bridge loans that do not charge prepayment penalties.

You should also consider how long it may take to earn income to pay off a short-term loan. 

If you cannot afford regular repayments, try looking for something with a longer payment period.

Shorter-term bridge loans require more frequent payments. Some lender agreements even stipulate that the borrower has to make daily payments.

A bridge loan offers;

  • Short-term financing
  • Fast, convenient funding
  • Quicker and easier to get than traditional loans
  • A versatile cash flow solution
  • Short repayment period
  • Flexible payment options 


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living room

Requirements for bridge loan financing

A bridge loan lender will look at a few requirements to see if you qualify for a loan including:


Affordability. Lenders will look at whether you have enough income to cover the payments.

Housing market. If your home is in a sluggish housing market, you may not qualify for a bridge loan.

Good credit. You can get bridge loan financing if your credit score is below 680, but not lower than 650.

Down payment. Lenders may require that you to make a 20% to 30% down payment. Some may require higher down payment of 50 percent.

Loan amount. Lenders evaluate a combination of the loan-to-cost (LTC) ratio and the loan-to-value (LTV) ratio. 

Lenders typically offer loans with 65 percent to 80 percent LTC. LTC is estimated based on the acquisition cost of the property along with the projected cost of renovation. 

Bridge loan lenders offer up to 80 percent LTV based on the property’s completed value.

After-repair-value (AVR). Bridge loan lenders approve financing on the basis of the after-repair-value (ARV). 

This percentage allows lenders to gauge the property’s future value over of its current price.

Debt service coverage ratio (DSCR). This measures your ability to repay the debt. DSCR is estimated by taking a property’s annual net operating income (NOI), and dividing it by the annual total debt service. Lenders require a DSCR of 1.1% to 1.25%.

Net Worth. Lenders check your financial records including statements. They evaluate the records to check your net worth.

Business experience. Lenders may require a company profile and business plan. This should demonstrate your knowledge and experience in the industry. 

Lenders also evaluate the business proposal, as well as similar projects you have completed successfully in the past.

Documentation required:

  • Credit report
  • Tax returns
  • Business plan
  • Company profile
  • Breakdown of renovation costs and schedule
  • Details of exit strategy (refinancing, selling, or other funding sources) 


Bridge loan financing structure and terms

Some bridge loans can be as short as 6 months. Most lenders offer 1 year to 3 year terms. The loans come with an interest-only payment.

 
A borrower has to cover monthly interest charges for the entire loan. When the loan term is expired, a balloon payment must be made to pay off the remaining loan balance. 


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Bridge loan fees

Expect to pay 1.5% to 3% of the loan amount in closing costs for a bridge loan. The interest rates can be as high as 8% to 10%, depending on the loan amount and credit profile.

 
Interest rates for bridge loans are based on the six-month LIBOR index and a spread of 4.5 to 5.5 points. This estimate depends on the property and the lender. 


Bridge loan financing options

The four main options of bridge loan financing include;

Closed loan

Offer a predetermined fixed repayment period which lowers the risk to the lender, and competitive loan interest rates.

Open loan

Have a fixed repayment date. Carry a higher interest rate and lenders may deduct interest from the initial loan amount to limit risks.

First charge loan

This gives a lender a senior position in the capital structure. It allows them to receive money before other lenders if there is a default on the loan.

Second charge loan

Offers a higher rate of interest to compensate for the increased risk of loss during default. The lender takes on greater underwriting risk.

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Types of bridge loans for businesses


Short-term loans

Short-term loans deal with smaller loan amounts and offer shorter repayment periods. 

Repayment schedules are not longer than 18 months. The loans are much easier to secure. 

Small businesses can gain approval in a day. Interest rates are significantly higher up to 10% or higher.

Business line of credit

A business line of credit works like a company credit card. Limits are much higher than those on credit cards. 

A business line of credit requires that you pay interest on the funds that you use. 

Most lenders require that you use a large initial loan amount. Interest rates are relatively high at 8% or more.

Accounts receivable financing

Accounts receivable financing allows businesses to use future revenue for current cash flow problems. This type of bridge loan can offer cash using an unpaid invoice. 

The business has to pay a weekly fee until they are able to cover the full cost of the loan. It is an expensive option despite the low interest rates.

Merchant cash advance

A merchant cash advance involves an alternative lender giving a business a predetermined loan amount upfront to spend as they see fit. 

The cash is repaid with interest. The business also has to pay the lender a small percentage of the sales. 

This is a more expensive type of bridge loan for businesses.

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Where to find bridge loan lenders

Not all lenders offer bridge loans. If you are looking for a bridge loan, you may want consider these options:

Credit unions & banks

Ask your local bank about bridge loan financing.

Non-qualified mortgage lenders

They specialize in alternative mortgage products like bridge loans.

Hard money lenders

May offer bridge loans short repayment terms.

Verify that a lender is appropriately licensed.

How to repay a bridge loan

Bridge loans must be repaid within 12 months or less. A bridge loan may have a balloon payment at the end where the full loan amount is due by a certain date. 

You may be able to wait a few months after the close of the bridge loan before making payments. This depends on the bridge loan you have been approved for.


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How to refinance a bridge loan

The main purpose of a bridge loan is to get some quick cash. Once you have spent the funds from a bridge loan to fix your cash flow, it is more economical to switch over to a long-term loan.

You can refinance your bridge loan. If you meet the qualifications, you can turn to a lender such as a bank to work out a more favorable long-term solution to pay off your bridge loan.

If a lender denies you a loan, you can apply for a small business loan (SBA) as an alternative option. 

This is a low risk option for lenders and is backed by the government. 


Bridge loan alternatives

Before you apply for a bridge loan, consider alternatives such as:

  • Cash-out refinance.
  • Home equity line of credit:
  • Home equity loan.
  • 80-10-10 loan.  


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Common uses of a bridge loan

It is much easier to gain approval for a bridge loan. Most lenders offer more lenient qualifications for businesses looking to take out a loan.

Applications are also streamlined and you can get same-day approval for bridge loans. 

Bridge loans can be used across a wide variety of industries, from service to manufacturing.

They can be used to address short-term cash flow problems that may affect the future success of a business. 

Some common uses of a bridge loan includes; 

Buying real estate

Bridge loans give businesses the option to get their hands on cash in less time. 

This allows a company to purchase a property to boost its future revenue. 

A business may refinance the bridge loan after buying the real estate deal with more economical long-term financing.

Fixing a property

Small businesses can use a bridge loan if they need to fix up a property. After renovations, they can refinance the bridge loan with a traditional long-term loan.

Cash flow

It can take months or even years to attract the attention of an investor. To avoid cash flow problems, a small business can make use of a bridge loan. 

This helps to cover costs such as rent, utilities, wages, and more.


Starting a Business

Bridge loans are ideal for startup businesses with no significant sources of revenue yet. 

It can help to cover costs as they become established and create a customer base. 

Bridge loans can help to cover expenses such as materials and labor, and it can be repaid upon delivery of the goods.

Loan refinancing

Refinancing is getting a new loan to replace your existing loan. This is an exit strategy you use once the short term on a bridge loan has expired.

Relocating your business

The bridge loan can be used as a down payment to buy a new business location and pay off the remaining mortgage on your current property.

If you do not have a down payment, a bridge loan can work for you.

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When to use a bridge loan

  • Sellers in your location will not accept contingent offers.
  • You cannot afford a down payment without the proceeds from your current home.
  • You are confident your home will sell but prefer to secure a new house before listing it.
  • Closing on your current home is scheduled after the closing date for your new home.
  • Businesses turn to bridge loans when they are waiting for long-term financing and need money to cover expenses in the interim. 
  • A business may use a bridge loan to provide working capital to cover its payroll, rent, utilities, inventory costs, and other expenses.
  • If a buyer has a lag between the purchase of one property and the sale of another, they may turn to a bridge loan. 

Lenders offer real estate bridge loans to borrowers with excellent credit ratings and low debt-to-income ratios.

Bridge loans have a faster application, approval, and funding process than traditional loans. 

These loans have short terms, high interest rates, and large origination fees. Most bridge loans do not have repayment penalties. 


Advantages of bridge loans

  • Take more time to sell your current house.
  • Keep your savings intact.
  • Make offers without a contingency and appeal to sellers.
  • Make interest-only payments until your house sells.
  • Move from your current house without having to rent or store your belongings.
  • Allows you to qualify with a credit score below 680 but not lower than 650
  • Comes with faster processing and approval
  • Allows you to take financing without relinquishing control of your business
  • Stabilizes your cash flow and covers business costs while waiting for payments
  • Not exclusive to owner-occupied properties and can be used for investment properties 


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Disadvantages of bridge loans

  • Pay relatively high interest rates plus closing costs.
  • Have a higher risk of foreclosure since your house is the collateral.
  • Have to make payments on multiple mortgages.
  • May be harder to find a lender.
  • Have fewer federal protections.
  • Make a larger down payment than you could otherwise.
  • Higher interest rates meaning higher monthly payments
  • The short term means reduced time to get funds to repay the loan
  • If you don’t have enough funds, you need to make sure you can refinance your loan before the term ends
  • If you default on your loan, the lender will seize your property and sell it
  • More expensive with greater upfront fees and higher rates.
  • Origination fees for bridge loans can be high as much as 3% of the loan value. 

To be approved for a bridge loan requires strong credit and stable finances. Lenders may set minimum credit scores and debt-to-income ratios.

If your home does not sell by the time you need to begin repaying your bridge loan, you will still be responsible for the debt. 

If you default on your bridge loan, the lender may foreclose on the home that you are trying to sell.

A bridge loan may seem attractive, but you should weigh the costs and risks carefully. 

Before you apply for a bridge loan, you may want to consider other financing options. 

There are alternative financing options such as a home equity line of credit, personal loan, 401(k) loan or home equity conversion mortgage.

These loans could have reduced risk levels and fees when compared to bridge loans. 

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