The COVID-19 pandemic has created an interesting scenario in the alternative lending market. Government agencies at every level, known for speaking negatively about bridge loans, suddenly find themselves in a position of giving away millions of dollars in alternative funding to small businesses trying to stay afloat. But as with anything the government does, catches abound.
Small businesses considering government bridge loans should step back and look at all the fine details before signing on the dotted line. The fact is that government bridge loans are not the same thing as private bridge loans. The two types of loans are drastically different.
How Government Loans Work
A bridge loan, by its definition, is a short-term loan intended to bridge the gap between existing and future finances. That much is similar between government and private bridge loans. Beyond that similarity though, the two types of loans diverge.
To explain how bridge loans from government entities work, we will use the city of Austin, Texas. The city has allocated some $5.6 million to be loaned to local small businesses suffering due to COVID-19 closures. As of early May, roughly $648,000 had been disbursed to 20 borrowers.
Each small business choosing to apply could receive up to $35,000 if approved. The money has to be repaid as soon as the borrower receives a federal loan from the SBA’s Economic Injury Disaster Loan Program or within 12 months, whichever is sooner.
This all sounds reasonable. The problem is that many small businesses in Austin could not apply prior to the loan program’s deadline because they were not sure they would receive a federal loan. Without such assurances, they also could not guarantee they would be able to repay what was borrowed within 12-month timeframe. Thus, the risk of accepting a bridge loan was too high.
This is the problem with government loans. They promise the world without divulging details. Once you get into the details though, they are suddenly not as attractive.
How Private Loans Work
Private bridge loans also have to be repaid. Private money is not free money. But the way loans are awarded and repaid is different. First and foremost, private bridge loans are not handed out to anyone and everyone who needs funding. Borrowers still must have the means to repay and a fairly trustworthy exit plan before hard money lenders will consider their projects.
Another significant difference is that private lenders require borrowers to offer collateral against their bridge loans. According to the private lenders at Utah’s Actium Partners, collateral is the primary consideration that can make or break a loan application.
One last difference is flexibility. Where government loans are issued according to strict rules that do not account for individual needs, private lenders are able to address each loan application as a separate entity. They have the flexibility to adjust everything from rates and terms to LTV so as to accommodate a borrower’s circumstances.
Access vs. Risk
Comparing government and private bridge loans side-by-side boils down to access and risk. Government loans are easier to access because the point is to help as many small businesses as possible. Even those who truly cannot afford to take a government loan are given the opportunity in hopes that they will eventually figure it out.
Private bridge loans are not so easy to access. But they do offer a lot more security. Lenders are protected by doing their due diligence and securing worthy collateral. Borrowers are protected by not being allowed to take loans they cannot afford to repay. Sound financial principles dictate that private lending is better.