The Risks of Bridge Financing

Many business and households use bridge financing as a method to secure immediate cash flow while more permanent financing options are pending. Business financing can take months to arrange as legal and insurance issues are handled. The same is true for large home loans. If you need funding in the mean time, bridge loans can help cover the gap. The loans do come with their own unique set of risks, however.

Loan Matures Quickly

Short-term loans mature very quickly. Most bridge loans must be paid off in full within a matter of months to a year at the most. If the loan is relatively small, this may be financially manageable. If the loan is large, however, monthly payments may be extremely high in order to close the gap quickly. For example, if you use a bridge loan to finance the initial equipment purchases needed to start a business, you may be looking at debt in the hundreds of thousands. This needs to be paid off before your business can secure an operating line of credit you may need to obtain supplies from vendors. The result can be a tremendous amount of pressure at the very beginning for your new endeavor.

Permanent Funding May Fall Through

The whole goal of bridge financing is to fill a gap before permanent financing comes through. For example, home bridge financing may allow you to start an addition or rehabilitation project on your house. You can use the bridge financing to make a down payment or initial payments, then you will expect your larger, permanent loan to come through. If you never end up achieving that longer, larger loan, you may not have the funds to complete the project. Taking a bridge loan is always an uncertain step to achieving the ultimate loan you are looking for.

Debt May Prevent New Loans

Carrying a lot of debt early in your endeavor may actually prevent you from arranging larger forms of financing. Having a bridge loan means you will have a high debt load on your balance sheet; if you pay off the loan fast, this can benefit your credit score and your debt to asset ratio. If you are still in the process of paying off this initial loan, however, new lenders may not consider you an attractive loan candidate. Applying for a bridge loan and a long-term loan simultaneously can be difficult as lenders will see you did not have the funds available to get on your feet in the first place.

Default is Catastrophic

Defaulting on any loan can cause permanent financial damage, but defaulting on a bridge loan will do this right as you are looking to get started on a new endeavor. While aged businesses will have a long credit history to explain away a default, a new business will not have this benefit. A new home owner will be in the same position. If you take out a bridge loan, protect yourself against default by having an emergency fund and assuring each monthly payment is made before any additional expenses are purchased.