Loan Basics. Bridge the gap with a loan

Have you been caught in a situation where you have a loan disbursement coming up but have to make an initial payment immediately? Or do you have some receivables coming in the future, but need some immediate capital for business operation? Bridge loans can help meet your short-term cash requirement..

These are short-term loans that can be availed of by both individuals and businesses. According to experts, maximum demand for this product comes from the business segment than retail customers. Only a couple of institutions offer it explicitly as a “bridge loan”.

For instance, State Bank of India (SBI) offers SBI – Bridge Home Loans for upgrading homes or building one at a new location (second home).

Bank of Baroda offers bridge loans to corporates against their expected future cash flow. Though other players in the market do not offer this product explicitly in the same name, they have products that are named differently, but ideally fulfilling the conditions of a bridge loan. For example, consumer durable loans, pay day loans etc are nothing but variants of a bridge loan.

How it works?

If you are planning to buy your second home for which the loan disbursement may take some time, but you have to make the initial down payment to the builder, the documents pertaining to the actual loan can be used as a collateral for availing a bridge loan to make the initial payment.

Once the actual loan is availed of, a part of it can be used to close the bridge loan.

In case of businesses, if you are expecting to raise equity or waiting for money to flow in the form of an external commercial borrowing or foreign direct investment or from a general business loan, but have immediate working-capital requirements to keep the business running, bridge loans are an option. Bridge loans can be availed of by providing the necessary documents, indicating the future cash inflow as a collateral. Importantly, the collateral documents should be an assured form that confirms the future cash inflow without any pre-conditions.

Tenor and interest rate

As this product is meant to meet the short-term cash needs, the tenor is restricted to three to six months in most cases. For example, the loans offered to purchase electronic items such as mobile phones and laptops have a tenor of three to six months.

The maximum tenor will not exceed 12 months in any case. For instance, the tenor of the bridge loan offered by Bank of Baroda to corporates is capped at 12 months.

Since the loan tenor is short, the interest rates charged for bridge loans are typically higher. The rates are determined based on the collateral provided. Ranjit Punja, CEO and co-founder, CreditMantri, says, “Bridge loans tend to be expensive and can vary from case to case. If you have a sanctioned letter from the final lender which does not contain any pre-conditions, the interest rate tends to be lower.

But if you have some pre-conditions to be fulfilled before the actual loan is given, then the bridge lender will have higher risk in which case the interest rate could be higher”.

Experts say that the interest rates in a bridge loan are normally above 20 per cent. Vikas Kumar, co-founder and CTO, Loantap says, “Interest rate on bridge loans are typically between 20 per cent and 30 per cent or may be even higher. Getting a bridge loan below 20 per cent is very rare”.

The bridge loan can be repaid in the form of equated monthly instalment or even at one go, once the proceeds from the future cash flow are realised. In general, there are no charges for pre-payment in case of a bridge loan.

Alternative options

Given the high interest cost, a bridge loan can lead an individual into a debt trap. What if the expected cash flows don’t materialise? Look for other options before you go for a bridge loan.

Keeping an overdraft facility ready with your regular banking institution is one of the best ways to meet short-term cash emergencies. It can help save on interest cost.

“A smart way is to set up an overdraft facility and use it in times of emergency and for other short-term cash requirements instead of going for a bridge loan”, says Vikas. He also adds that if retail customers have multiple credit cards, they can use it smartly after understanding the bill cycle of each card clearly to fulfill the short-term needs.

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