Bridge loans: how they work, what they cost and how you get out

Why bridge loans exist

Long-term commercial lenders size loans on a property's current income. A half-empty or run-down building doesn't have much, so it can't get a big long-term loan, even if it'll be worth much more once it's fixed up. A bridge loan covers that gap: it funds the purchase and the renovation for a year or two, and a long-term loan on the improved property pays it off.

How a bridge loan differs from a regular loan

• Short term: usually 6 to 36 months, sometimes with paid extensions.
• Interest-only: you pay interest each month and owe the whole loan at the end.
• More expensive: a higher rate than long-term loans, plus points (an up-front fee, often 1–3% of the loan) and sometimes an exit fee.
• Sized on the plan, not today's income: as a share of the price and renovation (loan-to-cost), often capped at a share of the after-repair value.
• Renovation money comes in draws: the lender pays it out as work is finished, and you pay interest only on what's been drawn.

A worked example

A $2,000,000 apartment building needs $400,000 of work. Once it's renovated and leased at market rents, its NOI should be $195,000 and its value about $3,000,000. The bridge lender funds 80% of the price and all of the renovation at 10.5% for 18 months, with 2 points and a 0.5% exit fee. The work takes 9 months.

The buyer brings $470,000 to close (a $400,000 down payment, points and closing costs) and pays about $17,500 a month in interest once all the renovation money is out. By the end, they've put in about $781,000.

The exit: will the refinance pay it off?

Refinance gap = new long-term loan − bridge payoff

A long-term lender sizes the new loan with its usual DSCR, loan-to-value and debt yield rules, using the improved NOI and value. Here, at 6.5% over 30 years with a 1.25 minimum DSCR:

It works, but barely. If long-term rates are one point higher when the time comes (7.5%), the new loan drops to about $1,859,000 and the buyer must bring about $151,000 to pay off the bridge. If the renovated building earns 10% less than planned, the shortfall is about $159,000. That's the main risk of a bridge loan: the plan has to work and the lending market has to cooperate on a date you can't move.

How to make a bridge loan safer

• Test the exit at a higher rate and a lower NOI before you buy. The bridge loan calculator does both in its PDF report.
• Pick a term with a cushion. Renovations and lease-up usually take longer than planned.
• Ask about extensions up front: how many, how long and what they cost.
• Keep cash reserves for a refinance shortfall, cost overruns or a slow lease-up.

Residential investors use the same idea in the BRRRR method, often with a hard money loan as the bridge.