How Bridge Loans Work, and How to Plan Your Way Off One

A bridge loan gets you from one side to the other

A real estate bridge loan works the way the name sounds. It’s short-term money that gets an investor from a property that needs work to a property that’s finished, rented or sold.

Before you step onto a bridge, you want to know there’s solid ground on the other side. With a bridge loan, that ground is whatever pays the loan off when the work is done.

Why investors use bridge loans

Say you find a house with no kitchen. A bank won’t write a regular mortgage on it, because the house isn’t livable yet.

A bridge loan, often called hard money, will. Bridge lenders focus on the property and the plan for it, and they’re set up for houses a bank won’t touch. The loans have a few things in common:

• They’re short. Most run from six months to two years.
• They close fast. That speed helps an investor win a property at auction or beat other buyers to a deal.
• They cost more. The lender is taking on more risk by lending on a house in rough shape, and the price reflects it.

The rate is only part of the price

Most investors compare bridge loans on the interest rate. The full cost includes much more than that:

• Points and origination fees, paid upfront, usually as a percentage of the loan.
• Draw and inspection fees, charged when the lender releases renovation money and sends someone to check the work.
• Monthly interest, often interest-only, paid every month the loan is open.
• Property taxes and insurance, which you owe whether or not the house has a tenant.
• Lost rent, since an empty house under construction earns nothing.

Here’s an example. On a $250,000 bridge loan at an 11% interest-only rate, interest alone is about $2,292 a month. Add taxes and insurance on top. If the renovation runs four months late, that’s four more months of all of it, with no rent coming in to offset any of it.

That’s why the timeline usually matters more than the rate. A slightly cheaper loan doesn’t help much if the project runs long.

Every bridge loan needs an exit

Something has to pay off a bridge loan. In almost every case, it’s one of two things:

1. You sell the property once the work is done, and the sale pays off the loan.
2. You refinance into a long-term loan once the property is finished and rented.

Decide which one before you take the bridge loan. If you’re planning to sell, check what similar finished houses nearby have actually sold for, at today’s mortgage rates. If you’re planning to refinance, know which lender you’ll use and how much rent the property needs to bring in to qualify.

How refinancing out of a bridge loan works

Many investors refinance out of a bridge loan with a DSCR loan. A DSCR loan qualifies on whether the property’s rent covers its full monthly payment of principal, interest, taxes and insurance. The investor’s tax returns stay out of the file. Our DSCR explainer walks through the math.

That makes it a natural fit for a renovated rental. Once the house is fixed and leased, the rent is what qualifies the new loan.

This is where Brick City Capital, Leverage Companies’ lending division, fits in. Brick City Capital doesn’t make bridge loans. It makes the long-term DSCR loan that pays one off once the house is fixed and rented, and it closes in 21 days on average.

Five things to ask any bridge lender

Before you sign a bridge loan, get clear answers to these:

1. How many points, and when are they due? Most are paid at closing, and some lenders charge more at payoff.
2. How do renovation draws work? Ask how long it takes to release money after an inspection, because a slow draw can stall your contractor.
3. What does an extension cost? If the project runs late, you’ll want to know the fee and terms for more time before you need it.
4. Is there a prepayment penalty or minimum interest? Some bridge loans charge a set number of months of interest even if you pay off early.
5. What happens at maturity? Know exactly what’s owed on the last day, and what the lender does if the loan isn’t paid off.

Put the answers next to your renovation schedule. Once a project runs long, those terms can cost more than the rate does.

One question to ask before you sign

Before you take a bridge loan, ask yourself: if the work finished tomorrow, who would pay this loan off?

If you can name the buyer’s price or the lender and the rent the property needs to qualify, you have an exit. If you can’t answer, work that out before you step onto the bridge.