Everyone has an investment idea that keeps popping up in their mind. It could be buying a new home, a piece of land or setting up a brick-and-mortar that also has good success potential online.
Financing the idea, as many people often find out, can be the biggest challenge. You could, for example, raise 25% of the initial capital using other people’s money such as from family and friends’ donations. But then, you realise that the remaining 75% is urgent for you to fully acquire the property.
If the urgency is quite high and you are confident to a high level that profitability of the venture is high and not in doubt, a bridge loan is one good option to consider.
This article explains what bridge loans are and investment ideas bridging debts can facilitate their implementation.
A bridge loan refers to short-term financing that allows an individual, business or entity some time and flexibility to acquire property or run a business until it secures permanent financing.
Also known as a swing loan, bridging financing, gap financing or interim financing, a bridge loan typically has a tenure of up to six months or one year and is secured by collateral like home, land or business assets.
Given the short-term nature of the bridge loan and the fact that they are supposed to build a literal bridge in the gap between short term cash needs and long-term goals, bridge loans can attract relatively higher interest rates as compared to traditional long-term loans.
Bridge loans are quite popular in the real estate industry where a homeowner or rental/commercial property owner can utilise the cash provided as they await the sale of another property.
Bridge loans vary depending on the interest rate, repayment method and period. Some will require monthly payments while others require only one lump-sum payment at the end of the loan term. Based on these factors, there are four types of bridge loans:
A closed bridge loan means the repayment period is predetermined by the loan parties. For instance, if it is one year, the loan should be serviced within that period. Here, the interest rate is generally seen as fair.
This kind of financing gives room for the borrower to repay the loan at any time. The repayment method is not determined by both parties and there is no fixed period. Most lenders would deduct interest before disbursing the loan to the borrower for security. Typically, this type of a bridge loan will attract high interest rates.
The first charge means the first lender takes priority over the property and in case of loan default, the lender takes the property. If there are other lenders involved in the financing of the property, they will receive the share after the first charge lender. The loan interest rate is fair due to its low underwriting risk.
Here, the second charge lender takes the payment after the first charge lender is cleared. It is only issued for a shorter period and attracts a higher interest rate. But both first charge and second charge lenders can repossess the property in case of default.
Owning a home is a dream for most people, especially those with families. But due to the prohibitively high initial cost of houses, it can be out of reach of most people. And even when a good deal comes up, there may be no money lying around to snap it up.
If you get a good deal on a property and do not have cash in hand to raise the deposit but believe making the purchase now would be beneficial, a bridge loan can be quite helpful.
You could get a bridge loan to secure this property without the hustle and bustle of waiting for a traditional loan.
You can then pay it back once you have earned an income from your regular streams. The biggest advantage here is the speed with which the relatively large amount can be disbursed.
While some Kenyans choose to buy homes that are already completed, many others take the route of building their own homes step by step.
Getting a plot of land in the right place to build a home is probably one of the biggest decisions one has to make. And just like the good deal on a ready home, the best plot may be found when you are not as liquid as required.
To avoid a shift in prices, you could apply for a bridge loan. It will give you access to additional money with which to purchase a piece of land at the prevailing rate.
Perhaps you have a real estate property that you wish to renovate to increase its market value or sell within the prevailing market conditions. This involves selling a property over a shorter time period to gain interest. A bridge loan could be the right financing for you.
For instance, you could plan to renovate 50% of the property units by installing new kitchen appliances, granite countertops, new flooring, and paint.
This could enable you to raise rental rates for the tenants and earn you much more in rental income. This will typically be much higher than any interest you will have to pay.
Working capital refers to the operational cost of a business. You could be having a business but its working capital has decreased, making it difficult to run its operations. A bridge loan is significant in fixing such scenarios due to its flexibility.
You could apply for the loan to finance expenses such as utility bills, payroll, rent, and inventory costs. The loan could also help the business to take advantage of limited-time offers on inventory, clearing suppliers and meet other business needs on time.
Secures investment opportunities: Bridge loans are flexible and fast to secure. For projects like home purchases, and home renovation, that require faster funding, this kind of loan is useful. You could use it to buy a new house before you sell your current home.
Removes sale contingencies from your offer: A sale contingency is a clause used in the real estate contract, that gives the buyer some time to sell an existing property, in order to finance a new one. You could make an offer on a new property without implementing a sale contingency with a bridge loan.
Faster and time-sensitive: There are projects that would require immediate funding depending on the market situation. For instance, if the land value changes every year, the loan provides immediate funds to purchase it. It is also helpful for financing through periods of uncertainty.
Non-recourse: This means lenders of the bridge loan are repaid through the property itself and not any other assets of the borrower even if the value of the property becomes lower than the owed amount.
Flexible repayment: The loan allows for flexible payment terms depending on the agreements. You could start paying off the loan before or after securing long-term financing. It gives the prospect of not servicing the loan on a monthly basis for the first few months. You could defer payments until you sell or pay after earning interest.
High-interest rate: The flexible nature of bridge loan and faster processing makes its payment expensive. Being a short-term loan, lenders increase its payment terms including charging larger fees and penalties in cases of late payment.