Bridge Loan to meet Short-Term Liquidity Requirements

Have you ever come across a term called bridge financing or juggled to find a way to resolve your temporary cash crunch? Well, bridge financing may be of some help to you in meeting immediate cash requirements until the time you expect to realize revenue from other planned sources.

In this article, we are going to discuss:

  • What is a bridge loan?
  • Advantages of bridge financing
  • How does bridge financing work?
  • How are bridge loans distinct from traditional loans?
  • Bridge financing in India

Bridge loan – meaning

A bridge loan is a short-term loan, with a term of a few weeks to 12 months. Sometimes, small business owners want to make a strategic acquisition, acquire property, or make some other useful purchases. In such circumstances, bridge financing acts as an alternative to tying up exiting working capital finance or dipping into cash reserves. Such bridge loans are usually backed by asset collateral.

A bridge loan is also known as interim financing, gap financing, bridge financing, or a swing loan. Bridge loan financing allows for the disposal of current obligations by providing immediate cash flow to the loan seeker. These loans are used until a company or an individual secures permanent financing or satisfies an existing obligation.

A bridge loan scheme usually carries relatively high-interest rates and entails the incurrence of large origination fees. It is normally backed by some form of collateral/security like equity, debentures, etc. Nevertheless, businesses are willing to pay high-interest rates since the loan is short-term and plan to pay it off with low-interest, long-term financing quickly.

Normally, lenders or credit institutions only offer bridge finance to those borrowers that have outstanding credit ratings and low debt-to-income ratios. The loan amount extended and the interest rate charged is dependent on the borrower’s repayment capacity.

Bridge loan definition

A bridge loan is a form of gap financing scheme in which borrowers may access short-term loans to meet short-term liquidity requirements. It assists in bridging the gap between the short-term cash requirements of a borrower and long-term loans. It is utilized as a continuing source of finance until the borrower attains medium or long-term financing to replace it.

Example

Let us take an example to comprehend the term ‘bridge loan’. Suppose XYZ Company is doing a round of equity financing and it is expected to close in six months from now. In this case, XYZ Company can opt to use a bridge financing scheme to cover its payroll, rent, utilities, and other expenses. Such loan shall be able to provide the needed funds until the round of equity funding goes through.

Banks usually provide bridge finance against the expected proceeds of non-convertible debentures, global depository receipts, equity, etc. provided the borrowing company has already made arrangements for raising the funds.

Advantages of bridge financing

Some of the benefits of using a bridge loan as a means of finance are as follows:

  • It is characterized by a faster application, approval, and funding process than traditional loans.
  • It bridges the gap when financing is needed but not yet available.
  • It offers convenient access to funds.
  • Bridge financing schemes have flexible terms of payment depending on the loan arrangement. You may opt to start paying off the loan before or after obtaining long-term funding or selling your old house.

How does a bridge loan work?

Bridge financing schemes can be used by both corporations as well as individuals.

From a corporation’s viewpoint, bridge loans bridge the time gap between the point that the company’s capital is expected to run out and when it can expect to obtain an influx of funds later. This form of funding is most widely used to meet the short-term working capital needs of a company.

Imagine that QPR Co. is approved for a Rs. 15 lakhs loan in a bank, but the loan is broken down, meaning it consists of three components (three installments). Within six months, the first installment will be cleared. The company needs funds to survive at the moment and will, therefore, be searching for a cover for the said six months. It may apply for a six-month bridge loan that will provide enough money to survive before the first credit installment flows into the company’s bank account.

Also, homeowners may use bridge finance to buy a new home while they wait for their current home to be sold. This renders them some extra income and flexibility to meet petty expenses until the time they generate revenue from the sale of the old house.

Suppose an individual’s present home is valued at Rs. 6,00,000 and the existing mortgage loan has an outstanding balance due at Rs. 3,00,000. He has found a new home that he wishes to acquire for Rs. 9,00,000. Now, a mortgage lender may offer him (bridge finance) up to 80% of the loan-to-value ratio of his current home, in this case, 80% of the home’s value is Rs. 4,80,000. Rs. 3,00,000 of this receipt will go towards paying off the existing mortgage. The remaining Rs. 1,80,000 will go towards closing costs for the bridge loan (land transfer tax, etc.) and a down payment on the new mortgage loan.

This way he would be able to move into his new home before selling the current one. Once the old property sells off, he shall pay off the bridge loan plus any fees and interest and would be left with cash to pay off one or two monthly payments on his new mortgage loan.

Bridge loan

How are bridge loans distinct from traditional loans?

In return for convenience, bridge loans appear to have relatively short terms, exorbitant interest rates, and high origination fees in comparison to traditional loans. Borrowers typically accept these terms because such loans enable easy and convenient access to funds. They are prepared to afford high-interest rates because they know the debt is short-term and they expect to pay off it comfortably with low-cost, long-term financing.

Bridge loan in India

Below are some of the bridge financing schemes offered in India.

Provider NameBridge Loan Interest Rate
Bank of Baroda10.25% onwards
Bridge loan SBI10.35% onwards
HDFC Bank12.30% onwards
Piramal Capital and Housing Finance16.55% onwards

Some of the documents required to successfully apply for a ‘bridge financing scheme’ in India include a duly-filled application form, passport size photograph, income tax (ITR) details, identification proof, last 6 months’ bank statement, income proof, proof of identity of the business, residential proof, a cheque for the processing fee, property-related documents, and GST identification number if any.

The eligibility criteria to avail bridge finance vary according to the specific requirements of a particular bank. But, typically all Indian residents with a minimum of 21 years of age and a maximum of 65 years of age may apply.

Also, the maximum repayment tenure of a bridge loan in India may go up to 24 months or 2 years.

Takeaway

Bridge loans offer a great financing tool as they are packed with the following features:

Features of bridge loan

Hope the information provided in this article proves helpful to you!

Also read: Angel Investment: What it holds for you?

Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

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