A bridge loan is a form of financing available for the short term, during which you can use it to meet your current obligations before you secure permanent financing. With it, you can get immediate cash flow during situations when you need funding but not yet available. However, it comes with higher interest rates and has to be backed by collateral like a real estate property or business inventory. You can access the loan as an individual or as a company for meeting certain obligations. Read on to learn more about short term bridge loans and their types:
How Do Bridge Loans Work?
A bridge loan is often used in the real estate industry for making a down payment for a new house. If you are a homeowner who wants to buy a house, there are two options for you. The first one is to add a contingency in the contract for your new home that you intend to buy. This contingency will state that you can buy the house only after your old house has been sold. However, there are some sellers who don’t take this option if there are other buyers who are willing to buy the new house instantly. Your second option is to pay a down payment for the new house by taking a loan before you complete the sale of your old house. You can use the hold house as collateral to get a bridge loan. Once you sell the old house, you can use it to pay the loan. In most cases, you can get a bridge loan that is worth 80% of both houses’ combined value.
Companies and business owners also take bridge loans for covering expenses and financing their working capital while they wait for long-term financing. Thanks to the bridge loan, they can cover their expenses like inventory costs, payroll, rent, and utility bills. Distressed businesses often take up short-term bridge loans for ensuring that their business smoothly runs while searching for an acquirer or an investor. In some cases, the lender takes an equity position to protect their interests in the company.
Types of Bridge Loans
Bridge loans are of four types:
1. Closed Bridging Loans
This type of bridge loan is given for a time frame predetermined and agreed upon by both parties. Most lenders accept the closed bridging loan because it gives them increased certainty about the repayment. Also, it attracts lower interest rates than other types of bridge loans.
2. Open Bridging Loan
For this type of bridge loan, the repayment method is undetermined during the initial inquiry, and there isn’t any fixed payoff date. To ensure their fund’s security, lenders deduct the interest from the loan advance itself. Open bridge loans are preferred by people who are not sure when they will get the finance. Because of the uncertainty, this type of bridge loan comes with a higher interest rate.
3. First Charge Bridging Loan
This type of loan gives the lender the first charge over your property. In case of a default, they will receive their money first before any other lenders. Because of the low level of risk, this loan has lower interest rates than second charge bridge loans.
4. Second Charge Bridging Loan
In this type of loan, the lender gets a second charge of the property. It is available only for a short duration, usually less than a year. Since this has a high risk of default, it attracts a high-interest rate. The lender will only begin recouping payment after all the liabilities accrued to the first charge lender have been paid.
There are a lot of advantages to this short-term form of financing. Even though, make sure that you do your research before signing up for the short term bridge loans.