Bridging a bank refinance that isn't ready yet: timing, prepaid interest and early repayment

A lot of our loans exist for one reason: the bank is going to say yes, but not in time. The existing facility expires, the settlement date is fixed, or the business needs to clear a problem before the bank will look at it, and the bank's process takes weeks or months longer than the deadline allows. A short-term private loan covers that gap, and the bank refinances it once the approval comes through.

It's a simple idea, but the costs depend almost entirely on how the interest is set up and what happens if you repay early, so that's what this guide covers.

When a bridge to a bank makes sense

• A facility is expiring and the new lender's credit process isn't finished.
• A purchase has a fixed settlement date and the bank's approval, valuation or lease review won't be done in time.
• Something needs fixing first, like a tax debt, a missed payment or a messy structure, and the bank will lend once it's cleared and there's a few months of clean conduct.
• You're selling one property to reduce debt and need to buy or refinance before that sale settles.

An example

We settled a bridging loan in Sydney that refinanced an existing bank loan over one property and funded the purchase of another. The loan was sized against the combined value of both properties, several months of interest were paid upfront, and the plan was to sell the first property and then refinance whatever was left to a cheaper lender. The prepaid interest meant there were no monthly payments to worry about while the sale ran, and the early repayment cost was set out in the term sheet from day one, so the borrowers knew exactly what it would cost to repay early. (Details have been changed to protect the client.)

Prepaid, capitalised or serviced interest

There are three ways to pay interest on a private loan, and each one changes how much cash you receive at settlement.

• Prepaid: a set number of months of interest is paid upfront, taken out of the loan at settlement. You receive less cash on day one, but there's nothing to pay monthly.
• Capitalised: interest is added to the loan balance each month and paid when the loan is repaid. You receive more cash at settlement, but the balance grows.
• Serviced: you pay interest monthly from your own cash flow, like a normal loan.

Many loans combine them, for example a few months capitalised and the rest serviced once a business has had time to settle down.

A worked example

These numbers are illustrative only and aren't a quote.

Say a company borrows $3,000,000 for up to 12 months at an illustrative rate of 10.00% a year, with 6 months of interest prepaid.

• Prepaid interest: $3,000,000 x 10.00% x 6/12 = $150,000, deducted at settlement
• Cash available at settlement, before fees and costs: $2,850,000

Now say the bank approves the refinance and the loan is repaid after 4 months.

• Interest actually used: $3,000,000 x 10.00% x 4/12 = $100,000
• Unused prepaid interest: $50,000

What happens to that $50,000 depends on the loan terms, and this is the part people often don't read.

• If the loan has a 6 month minimum term, you pay 6 months of interest however early you repay, so the $50,000 isn't refunded.
• If there's no minimum term, or it's already passed, the unused interest is usually credited back against the payout.
• An early repayment fee may also apply. An illustrative fee of 0.25% on $3,000,000 would be $7,500 plus GST.

If the same loan had capitalised interest instead, you'd receive the full $3,000,000 at settlement (before fees), and after 4 months you'd owe roughly $3,100,000, a little more because the interest compounds monthly. There's no refund question, because you only pay for the months you use, subject to any minimum term.

How to set it up so the refinance goes smoothly

1. Match the term to the bank's realistic timeline, then add a buffer. If the bank says six weeks, plan for three to four months, and pick a minimum term that fits.
2. Choose the interest method based on cash, not habit. Prepaid suits a borrower who wants certainty and no monthly payments. Capitalised suits a borrower who needs every dollar at settlement and expects to repay early.
3. Ask exactly what early repayment costs. Minimum term, refund of unused prepaid interest and any exit fee should all be written in the term sheet before you sign.
4. Keep the bank in the loop. Give the bank the private loan's terms early, so its credit team isn't surprised by the payout figure.
5. Keep conduct clean. If the bank is waiting to see a few months of good repayments or a cleared tax debt, make sure nothing goes wrong in that window.

How we do it

We tell you the total interest, every fee and the exact payout at the end before you sign, and we set the loan up with the bank's refinance as the planned exit. We lend $1M to $20M for business and investment purposes, secured by property on the East Coast, and we normally settle in 5 to 10 business days once the valuation is in.

If your bank approval is running behind a deadline, send us the scenario and we'll tell you quickly whether a bridge works.