As the name suggests, bridging loans are a type of short term debt finance used by business owners who need a quick injection of funds to cover a gap in cash flow. They can be taken out over a few weeks or months – generally up to around a year – to ensure the business can operate healthily when revenues are down, or a large investment has had an impact on the enterprise’s available working capital.
A small business owner might take out a bridging loan if they are looking to buying equipment, build up funds to prepare for expansion or stock up on inventory before a peak sales season. It can also be used to cover a period where the borrower is expecting a big windfall but they encounter a delay in payment.
A person who owns a clothing store, for example, might order next season’s stock anticipating, budgeting and forecasting based on the assumption the shipment would arrive within 30 days of payment. But, if the stock is unexpectedly held up and cannot be delivered for another 30 days, a bridge loan would allow them to “bridge” this gap. This type of fast loan would cover the loss in revenue, allowing the owner to trade in the interim period, and could be paid off with the projected sales of the upcoming season.
The cost of bridging loans do tend to be higher than longer-term financing options because they are a convenient solution to covering a short term cost. Because they are generally used by business owners who need a quick injection of cash to seize an opportunity or secure working capital needed in between payments, higher interest rates and loan origination fees are fairly common. Borrowers can usually expect lenders to charge additional fees and penalties on any late payments.
Borrowers do have the flexibility to choose how they structure a bridge loan and whether they would rather take on a closed loan, where the borrower knows exactly how they will be repaying the debt, or an open loan where a detailed plan is not required by the lender.
Bridge loan financing can come from banks, peer-to-peer lenders, business finance providers, or via a broker. They are typically quick to obtain with a fast application, approval and funding process – sometimes within 24 hours. Borrowers tend to be more willing to pay for this convenience through higher interest rates and origination fees because they are aware of the short term nature and know they will be able to pay it off with an incoming injection of cash. Most bridge loans will take the form of a secured loan, backed by the borrower’s property, inventory or equipment.
Someone taking out a bridge loan will typically be expecting a more significant, permanent cash injection coming in – such as the sale of goods, property or an insurance payout – that will ensure the loan is repaid. For example, if a business owner has big contract coming through in the near future but it is taking time to finalise, they might take out an interim bridge loan that can work as a good, short term stop gap.
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What are the main risks? Because of their short term nature, outright fees and interest rates tend to be higher for bridging loans. It is often advised to make sure there is a known injection of cash coming in that will pay off the loan to decrease the stress of debt burden or default. Because bridge loans often require collateral, borrowers also need to be aware of the potential risks if they default on their payment.
What are the main rewards? Bridge loans are a quick cash flow infusion that allows businesses and startups to seize opportunities or cover short term gaps in revenue. They are designed to be convenient and obtained quickly and easily. They also commonly allow for flexibility in how they are structured and paid off.
When is the ideal time to take out a bridge loan? If a business owner is considering taking out a bridge loan, its best to consider if it is the right option for their current needs. If they have an immediate cash shortfall with an anticipated inflow of funds around the corner – such as longer term financing, equity investment, insurance repayment or sale of an asset, a bridge loan would be a good option.
What collateral do I require for a bridge loan? While collateral is not always needed it is very common. Bridging loans are fairly flexile so they can be secured over a range of assets if required, typically as a fixed charge over property, plant or machinery or as a floating charge over all the assets and undertakings of the company.
What is the difference between a closed and an open bridge loan? The main difference between a closed and open bridge loan is whether an exit strategy for the loan is in place at the point it is lent. Agreeing to a closed loan would be to specify that, for example, the sale of an asset would be used to repay the loan. An open loan would typically be used when there is an urgent transaction that requires funding but it has not yet been determined exactly how the loan will be repaid and the business owner wants to give themselves more time to consider their options.
How much does a bridging loan cost? There are a number of fees that borrowers should be aware of when considering bridging loans in the UK. While they may not all apply for every loan, an arrangement fee will usually cost around 1-2% of the sum that is borrowed and an exit fee will be around the 1% mark as well. Some lenders may also require a repayment fee for the cost of administration and valuation fees to cover surveyor costs.
What is bridging finance? Bridging finance is the umbrella term for a financing option used to cover short term costs until longer term options are arranged. It most commonly takes the form of a loan – a bridge loan, as discussed in this article – but in some cases it can take the form of equity investment, such as taking a share of the business or the assets. Bridging finance rates will depend on the length and structure of the loan or the form of equity investment taken out.