From Application to Approval: How Does a Bridge Loan Work?

by Kieran Daly
April 4, 2024
From Application to Approval: How Does a Bridge Loan Work?

Bridge loans allow companies quick access to funds for a short period of time which can range from a few months to a year. Many people think bridge funding is only a financing option intended for the housing market — allowing a homeowner to make a new home purchase when their old home is still on the market or its sale’s closing date is after that of the new property. 

But this type of loan is also often used by companies. They’re designed to cover a shortfall in cash until an expected influx of capital arrives. If you need funding quickly but don’t want to wait for or don’t think your business would qualify for a traditional loan, a bridging loan may be the best solution.

Keep reading for answers to frequently asked questions about bridge loans, including:

  • What is a bridge loan?

  • How does a bridge loan work?

  • Why would someone get a bridge loan?

  • How do you apply for bridge financing?

  • How much do bridge loans cost?

What Is a Bridge Loan?

Bridge loans, also known as swing loans or hard-money loans, are a type of short-term financing designed to bridge a gap in funding.

Companies use bridge loans when they need to pay for something before they have the capital to cover the cost. Usually, the company is expecting an influx of capital that they know will offset the expense. They then repay the loan once they receive the capital they’re expecting.

Time is of the essence with bridge funding. The speed with which bridge lenders turn around applications and fund companies is much quicker than with traditional lenders.

Long-term financing is often not suitable in these circumstances for these reasons:

  • Time constraints: The delay between applying for a conventional loan and receiving the funds is often long. Bridge lenders often offer much faster processing times.

  • Loan purpose: Conventional lenders do not provide financing for many of the purposes bridge lending is used for, like covering operating expenses or funding an acquisition.

  • Collateral requirements: Many traditional lenders will only advance funds if you offer residential or commercial real estate as collateral. But some bridge lenders are happy to accept equipment, inventory, or accounts receivable — while some don’t require collateral at all.

  • Creditworthiness: Traditional banks and credit unions will often only lend to borrowers with higher credit scores. Some bridge lenders are happy to consider applications from companies and company principals with less-than-perfect credit scores.

How Does a Bridge Loan Work?

Bridge loans are short-term loans with repayment periods of one month to one year.

If the lender agrees to your application, they disperse the capital to you as a lump sum.

Where bridge loans differ from traditional mortgages or loans is that you make interest-only repayments throughout the loan term. You don’t make monthly payments toward the principal balance. This is to minimize the size of your repayments so you can hold onto as much cash as possible during the bridging period.

Repaying Your Bridge Loan

At the end of the loan term, you pay off the entire principal balance of the loan in one lump sum. You can repay faster if the payment you were expecting arrives sooner.

If the cash you’ve been expecting doesn’t arrive, you’ll normally have to apply for a bridge loan with another lender and use that to pay off your first lender.

Why Would Someone Get a Bridge Loan?

There are many use cases for a bridge loan. Each use case includes what the loan funds will be used for as well as a company’s planned exit strategy. An exit strategy is a future expected event that will generate the cash needed to repay the principal balance of the loan.

Here are some common use cases and their exit strategies for business bridge lending:

  • Inventory financing: Bridge loans allow companies to, for example, purchase a large amount of inventory to stock up for a busy season or fulfill a big order when they don’t have the cash at hand. The loan is then repaid when the business has sold the inventory and received payment from their customers.

  • Payroll and operating expenses: Companies can cover cash flow shortfalls, like payroll and other operating expenses, when they’re waiting for one or more clients to pay their invoices. When the invoices are settled, they then repay the loan.

  • Commercial property purchase: From time to time, a seller’s market will develop in commercial property — leading to offices, shops, and restaurants being snapped up quickly when they’re put on the market. Because commercial mortgages take time to arrange, companies can use a bridge loan to pay for a property and then refinance with a traditional mortgage.

  • Initial public offering (IPO) costs: Taking a company public incurs significant costs, like legal and underwriting fees. These expenses can be covered by a bridge loan, which can be settled once the business has received the proceeds from the IPO.

  • Acquisition financing: Businesses acquiring other companies use bridge lending to cover the purchase and associated costs. They then repay the loan when they have either secured long-term funding for the takeover or they have integrated the acquired company's cash flows.

  • Investment opportunities: With a bridge loan, investment fund managers can take advantage of opportunities, even if they don’t have investor cash on hand. Once investor cash has arrived or the investment has generated a large-enough return, they then settle the loan principal.

  • Equipment financing: Standard equipment finance requires a down payment of 20%. If a company does not have the capital to cover 20%, it can purchase machinery with a bridge loan with no down payment required. They then repay the loan from additional profits generated by the new equipment or by another expected influx of capital.

How Do You Apply for Bridge Financing?

You first have to decide on a lender or a broker and then you can apply for your bridge funding. Let’s take a closer look at what bridge lenders will look for and the steps of the application process.

What Lenders Look For

Lenders’ bridge loan requirements may vary, but many want to see through your application that you understand how a bridge loan works. So they’ll expect the following:

  • Defined loan purpose: You must state why you want a bridge loan and how you'll use the funds.

  • Creditworthiness: Although bridge lenders do approve applications from companies with less-than-perfect credit, you may pay higher interest rates if you have a lower credit score.

  • Collateral: Offering high-value collateral can improve the chances of your application being approved. If you can't offer real estate as collateral, look for a lender that will consider other assets. The quality of your collateral makes a difference to how much you can borrow. For example, you might be able to borrow up to 90% of the value of property but only 50% of accounts receivable.

  • Financial stability: Lenders will assess how able you are to repay the loan based on factors like your debt-to-income ratio (or DTI ratio) and how much revenue your business generates.

  • Exit strategy: You need to prepare a clear and detailed exit strategy to present to lenders with your application process.

The Application Process

There are several steps to applying for a bridging loan.

1. Start Preparing

First, you should thoroughly research bridge loan lenders and the loans they provide to see which one is best for your business.

While you're doing this, gather the documentation you'll need, like financial statements and information on your collateral. Be clear on what your exit plan is, and be ready to explain it along with the reason you need capital from a lender.

2. Approach Potential Funders

Next, reach out to the lenders and brokers you identified during your research and tell them what you need.

Ask them if a bridge loan is the most suitable option for your particular use case. Although you will pay a fee to a broker, using one may cost less because lenders frequently offer better deals through brokers than they offer directly to end users. 

In addition, a broker is more likely to know which lenders will entertain your application, saving you more time.

3. Submit Your Application

Once you've decided which lender or broker you'll apply through, submit your loan application together with the documentation required.

Take time to read the terms and conditions, and make sure you understand the loan terms. It may be best to ask a lawyer for their advice on this.

You should also check that you have enough collateral to secure the size of loan you require. If you don't, you may not be able to borrow as much, or you may need to introduce further capital.

4. Await the Decision

Your lender will then review your application, verify the information you've submitted, and assess your creditworthiness and collateral.

You may be asked to provide additional information or documentation by the lender as they come to a decision.

5. Sign the Agreement

If the lender approves your application, they'll then present a loan offer.

You should review this and, either directly or through your broker, attempt to negotiate for better terms or a lower interest rate. If you're happy with the agreement, sign it and send it back to the lender. You should then receive the funds within a few days.

How Much Do Bridge Loans Cost?

When you apply and receive bridge funding, you may pay some or all of the following fees.

Application and Processing Fees

  • Origination fees: Lenders charge a percentage of the total loan amount for processing your bridge loan application. This charge comes into effect when they approve your loan and transfer the capital to your account.

  • Legal and administrative fees: These lender fees cover the preparation and review of your bridge loan documentation.

Collateral-Related Fees

  • Appraisal fees: This is the cost of an independent assessor's appraisal of the value of the collateral you're pledging on the loan.

  • Title policy costs: When you get a bridge loan for a property, you have to pay for title insurance. This insurance protects you if there are any issues with the property's ownership records that could prevent the lender from enforcing their claim on the property if you can't pay back the loan.

  • Notary fees: This is the fee charged by the notary public for being a witness to the signing of the loan agreement and confirming the identity of the signers.

Ongoing Costs

  • High-interest rates: You may pay a higher interest rate on your bridge loan, close to what you would pay on a credit card or unsecured personal loan.

Other Fees

  • Broker fees: If you use a broker to arrange your bridge loan, they'll normally charge you a flat fee or a percentage of the principal.

  • Closing costs: Lenders charge closing costs to cover expenses like loan processing fees, underwriting fees, and document preparation fees when you sign the loan document.

Offer Your Clients More Funding Options With Backd

Once an entrepreneur knows how bridge loans work, they realize that there is a way of funding cash flow shortfalls, expanding their business, paying for equipment and inventory, and more.

Bridge funding's greatest strengths are quick access to funding, no down payments, and flexibility.

At Backd, we understand how important quick, flexible funding is. Backd offers businesses up to $2 million in funding with repayment plans tailored to their needs. We can approve and fund companies within 24 hours.

If you are an ISO broker with clients looking for bridge loans, get in touch with us and become a Backd partner.

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