Understanding Interim Financing

Investopedia specifies that a bridge loan is “A short-term loan that is used until a person or company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short-term (up to one year) with relatively high interest rates and are backed by some form of collateral such as real estate or inventory.”

Regardless of the circumstances for making a bridge loan, there must be some form of collateral to back it. In the case of a homeowner who is attempting to sell one home and purchase another, a bridge loan would be secured by the home that is being sold. In the case of a business, the lender may place a lien on the inventory, physical property or contracts that the company holds. These liens are released when the loan is repaid, which is exactly what happens with standard loans.

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Purchasing a business: In some cases, a homeowner who has a great deal of equity may be considering purchasing a business. While they are waiting for a business loan to be complete, they may elect to take a bridge loan. This would mean the lender would have a lien on their personal property while the loan was outstanding;

Land acquisition expenses: Some people who have decided to purchase land and have a home built may find that obtaining land and a construction loan is a longer process than they originally anticipated.

In this instance they may have other assets such as investment property, securities or cash value in a life insurance policy that would allow them to accept a bridge loan. This is an atypical example.

Because interim financing often involves high interest rates, there may be better options including home equity loans, loans against life insurance policies or personal loans. In extreme cases, interim financing may cause more financial problems than they help solve.

Understanding the risks

One of the challenges that these types of loans create is that because of the higher interest rates that are associated with them, the monthly payments could be burdensome. Additionally, there is no guarantee as to how quickly a home will sell or a construction loan will be complete.

The overall cost of a bridge loan can be staggering if it is not paid back within a short period of time. In addition, since these loans are typically good for only one year, a homeowner who is unable to sell their property may be facing foreclosure if they are unable to sell their home.

Businesses often use bridge financing to help fill the gaps between larger infusions of capital. This is fairly common when a company is considering a merger, considering a public offering of their stock for the first time or when they are considering expanding their operations. There are numerous forms of interim financing that business owners may take advantage of for these purposes.

Standard bridge loan - Business owners, who have physical property including real estate, may consider a standard bridge loan. In many cases, these loans are taken out for less than six (6) months and are tied to contracts with others. They are often used if a company is in the process of making a public stock offering;

Inventory financing - Borrowing money against inventory is another form of bridge financing. Not all businesses need the larger amounts of funding that would be available if they used real estate. In these cases, the loans could be repaid as the inventory was depleted. This type of financing is sometimes associated with large department stores or car dealerships;

Accounts receivable financing - Contract or accounts receivable financing is another possible consideration for a business that is in need of short term financing. In these cases, a lender would take over the receivables and pay the company a percentage (up to 80 percent) of the value of the receivables up front. In return, they would receive payments on these receivables until such time as the company no longer needed additional capital.

Because bridge financing tends to be more expensive than other types of financing, it is generally a good idea to determine if it is possible to borrow money from other sources. This is true for both personal bridge loans and business bridge loans. In addition, not all lenders are willing to make these types of loans as they often consider them more risky than other types of financing (hence the higher interest rates).

Before considering a bridge loan, it is a good idea to pursue other options. Home equity loans, loans against life insurance policies or personal loans may all be valid options. Interim financing options are needed for many reasons, however the high costs of these loans should be carefully weighed before accepting this type of financing.

Sources:

1. Investopedia Bridge Financing http://www.investopedia.com/terms/b/bridgeloan.asp
2. Business Finance Bridge Financing http://www.businessfinance.com/bridge-financing.htm
3. Real Estate ABC Real estate and Mortgage Insights http://www.realestateabc.com/insights/bridge.htm

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