What is a bridge loan? Definition and FAQs

Table of contents

• What is a bridge loan?
• Why use a bridge loan?
• How bridge loans work
• Features of bridge loans
• Pros and cons of bridge loans
• How is the amount calculated?
• How to get a bridge loan
• Get your business ready for funding
• FAQs on bridge loans

Key takeaways

• Apply for bridge loans when you have a clear repayment plan and timeline, as these short-term financing solutions typically last 12 months or less and require specific documentation of how you'll repay the funds.
• Prepare to pay higher interest rates and additional fees compared to traditional loans, since bridge loans prioritize speed and flexibility over cost-effectiveness.
• Secure adequate collateral such as property, equipment, or inventory before applying, as lenders use loan-to-value ratios and asset security to determine your borrowing amount.
• Contact your existing bank first when seeking bridge loan options, as they already understand your business and can provide faster approval processes than unfamiliar lenders.

What is a bridge loan?

A bridge loan is a short-term loan that helps businesses cover temporary cash flow gaps or take advantage of time-sensitive opportunities. It’s secured by existing assets, like property, inventory, or equipment, and provides quick access to funds while you wait for permanent financing or incoming payments.

Think of it like a real estate bridge loan—just as homeowners use one to buy a new house before selling their current home, businesses use a bridge loan to act fast without waiting for long-term funding.

Why use a bridge loan?

Bridge loans solve cash flow timing problems by providing quick access to funds when you can't wait for permanent financing.

These short-term loans help businesses:

• Respond to opportunities quickly: Secure deals or investments without waiting months for traditional loan approval
• Maintain operations: Keep paying suppliers, staff, and bills during cash flow gaps
• Bridge timing mismatches: Cover expenses while waiting for customer payments or insurance claims

Think of it like a real estate bridge loan – just as homeowners use them to buy a new house before selling their current one, businesses use them to access funds before permanent financing arrives.

Examples of bridge loan uses

Use a bridge loan to:

• cover expenses such as payroll, utilities, rent and inventory costs while waiting for long-term financing, which might come in several payments
• manage seasonal fluctuations in cash flow
• cover temporary cash flow gaps, such as delays in receiving payments from customers or when recovering from a large capital expense
• cover expenses while waiting for an insurance claim to pay out
• respond to time-sensitive opportunities, such as launching a product line or taking advantage of a deal to buy property

For example, you own a popular restaurant. Another owner is selling their business in a busy part of the city. You want to expand, but getting loan approval will take several months. The seller wants to move quickly, so you use a bridge loan to buy the restaurant and repay it when your long-term financing is approved.

How bridge loans work

A bridge loan uses the equity in an asset you already own, like your business premises or inventory, as security for a short-term loan.

This gives you the cash you need to act on an opportunity, such as buying new equipment or property, while you wait for your long-term financing to be approved.

When your main funding arrives, you use part of it to repay the bridge loan. This helps you avoid missing out on a good deal because of timing.

Features of bridge loans

Bridge loans are designed for speed and flexibility, offering quick access to larger amounts than credit cards or lines of credit. Here are their key characteristics:

• Short timeline: Usually 12 months or less
• Fast approval: Funding can happen in less than a week, much faster than traditional loans
• Higher costs: Interest rates are higher due to the short-term, higher-risk nature
• Flexible repayment: Choose between closed terms (specific repayment date) or open terms (flexible timeline)
• Collateral required: Secured by assets like property, equipment, or inventory
• Higher borrowing limits: Access more funds than unsecured financing options

Closed vs open terms: Closed loans are easier to get and have lower rates because lenders know exactly when you'll repay them.

Pros and cons of bridge loans

Bridge loans offer significant advantages when you need quick funding:

• Speed advantage: Get funded in less than a week vs. months for traditional loans
• Higher borrowing power: Access larger amounts than credit cards because loans are asset-secured
• Payment flexibility: Choose interest-only payments or capitalize fees and interest

But they come with notable risks:

• Higher costs: Interest rates are significantly higher than traditional loans
• Monthly interest calculations: Some lenders calculate interest monthly, not annually, increasing total costs
• Setup and exit fees: Additional costs for loan origination and early repayment
• Collateral risk: You could lose your assets if permanent funding falls through

Bridge loans work best when you have a clear repayment plan and the opportunity justifies the higher costs.

How is the amount calculated?

The amount you can borrow with a bridge loan isn't based on a fixed formula. Instead, lenders typically look at the loan-to-value ratio (LTV) of the asset you are using as collateral.

For instance, in real estate, regulators define high-ratio mortgages as those where the loan to value ratio was over 80% at the time of origination, requiring mortgage insurance.

They will also review your business's overall financial health, your credit history, and your plan for repaying the loan to decide on a final amount.

A clear and credible repayment strategy is key to securing the funds you need.

Ways to get a bridge loan

Getting approved for a bridge loan requires preparation and meeting specific lender criteria. Before applying, clarify three key points:

• Timeline: How long you'll need the funds
• Purpose: Exactly how you'll use the money
• Repayment strategy: How you'll pay back the loan

Qualification requirements:

• Credit history: Decent credit score and payment history
• Collateral: Assets like property, equipment, or inventory to secure the loan
• Show you can repay the loan: Provide proof of income or cash flow. Lenders often assess this using metrics like the Total Debt Service (TDS) ratio, which measures your ability to handle debt.
• Provide a clear plan for how you will repay the loan: Documentation of incoming payments, permanent financing, or asset sales

A detailed exit plan can make approval easier and help you get better rates.

To learn more about getting approved for bridge and traditional loans, check out our guide How to get a business loan.

Talk to your bank

If you need a bridge loan, talk to your bank first. Your bank already knows your business. Not all banks offer bridge loans, but some financial providers specialize in them. Make sure you choose a reputable provider.

Your accountant can also advise you and help provide the financial information about your business for the application. Using small business accounting software, like Xero, can make this process faster and easier.

The industry's growth highlights its importance; for example, one cloud-based accounting software provider raised over $130 million in equity and debt financing in a single year.

Get your business ready for funding with Xero

A bridge loan can be a powerful tool to seize time-sensitive opportunities without disrupting your cash flow. By understanding how they work and preparing your financials, you can make confident decisions for your business.

With clear, real-time insights from your accounting software, you'll have everything you need to support your application and show lenders you're a great investment. See how Xero accounting software can help you manage your finances.

Try Xero for free.

FAQs on bridge loans

Here are answers to some common questions small business owners have about bridge loans.

What is the main disadvantage of a bridge loan?

The primary drawbacks are the higher interest rates and fees compared to traditional, long-term loans. The short repayment period, often just a few months to a year, can also create financial pressure if your permanent funding is delayed.

What credit score do you need for a bridge loan?

There isn't a single required credit score, as each lender has different criteria. While a good credit history is beneficial, lenders often place more emphasis on the value of the collateral you provide and the strength of your repayment plan.

How long do you have to pay back a bridge loan?

Repayment periods are short, typically ranging from a few months up to a maximum of 12 months. The exact term is agreed upon with the lender and is usually timed to coincide with when you expect to receive your permanent financing or a large customer payment.