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Last reviewed: 13 October 2026

Commercial real estate owners often use two very different kinds of debt over the life of a property. A bridge loan finances a transition, such as a renovation or lease-up. Permanent debt finances a stabilised property for the long term. Choosing between them, and planning how one leads to the other, affects cash flow, flexibility and risk. This guide explains how the two compare, how lenders size loans, what regulators expect of banks and what to ask before you sign.

What bridge loans and permanent loans are

The Office of the Comptroller of the Currency (OCC), which supervises national banks, describes a bridge loan as short-term financing that lets newly built or acquired commercial properties reach stabilisation. It says bridge loans are usually written for up to three years and allow for the lease-up and income stabilisation needed for a sale or for permanent financing (OCC Comptroller’s Handbook, Commercial Real Estate Lending).

A partly leased office building with a timeline showing a short bridge loan followed by long-term permanent financing

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Permanent loans (also called term loans or take-outs) refinance construction or bridge loans once a property has stabilised, or finance the purchase of a property that is already stable. The same OCC handbook notes that life insurance companies, pension funds and commercial mortgage-backed securities (CMBS) lenders often provide terms of 10 years or more on a fixed-rate basis, and that these loans are commonly non-recourse.

Typical uses for a bridge loan

  • Value-add plans. Buying a property with below-market rents or deferred maintenance, then renovating and re-leasing it.
  • Lease-up. Financing a newly built or recently vacated building while tenants are signed.
  • Acquisition timing. Closing a purchase quickly when permanent financing cannot be arranged in time, or when the property does not yet qualify for it.
  • Repositioning. Changing a property’s use or tenant mix.

The common thread is that the lender is relying partly on a business plan that has not happened yet.

Structural differences

Feature Bridge loan (typical) Permanent loan (typical)
Term Short; the OCC says usually up to three years Longer; often 5–10 years or more
Payments Often interest-only, sometimes with an interest reserve Usually amortizing, sometimes with a partial interest-only period
Rate Often floating Often fixed
Underwriting basis Business plan and projected “as-stabilised” value Current, stabilised income
Recourse Varies; guarantees are common Often non-recourse with “bad-act” carve-outs
Prepayment Usually more flexible Often yield maintenance, defeasance or a step-down premium
Extension options Common, subject to conditions Less common

These are general patterns, not rules. Every loan agreement is different.

Interest-only payments and interest reserves

Interest-only payments keep debt service low during lease-up, but they leave the full principal due at maturity. The OCC notes that interest-only terms can increase the loss given default and the balloon repayment risk at maturity, and says a property should still meet a bank’s debt service coverage requirements as though the loan were amortizing.

Some loans include an interest reserve, where part of the loan is set aside to pay interest during construction or lease-up. The federal banking agencies have cautioned that if a project stalls, interest funded from the reserve can keep a loan contractually current even though the property is not producing enough cash to repay it (Policy Statement on Prudent CRE Loan Accommodations and Workouts).

Recourse vs non-recourse

With a recourse loan, the lender can pursue the borrower or guarantor personally if the property does not cover the debt. With a non-recourse loan, the lender generally looks only to the property. The OCC explains that non-recourse loans usually come with a guarantee covering losses from specified “bad acts”, such as fraud, voluntary bankruptcy, environmental problems, unapproved liens, waste or diverting funds, and that some carve-outs make the whole loan full recourse.

Extension options

Bridge loans often include one or more extension options. These usually require conditions such as no default, a minimum DSCR or debt yield, a fee, and sometimes a new or extended interest rate cap. The OCC says extension options should be consistent with the expected construction time plus the projected absorption period. Read the conditions closely; an extension you cannot qualify for does not reduce your maturity risk.

Prepayment terms explained

Permanent lenders often charge for early repayment because they or their investors expect a fixed stream of interest.

  • Yield maintenance. A premium designed to compensate the lender or investor for lost interest if the loan is repaid early. Fannie Mae describes it as a fee that applies during a set yield maintenance period (Fannie Mae DUS Program Overview).
  • Defeasance. Instead of repaying, the borrower substitutes a portfolio of securities that produces the remaining payments, releasing the property. Freddie Mac’s fixed-rate term sheet, for example, describes yield maintenance until securitisation, a two-year lockout, then defeasance, with no prepayment premium in the final 90 days (Freddie Mac Optigo Fixed-Rate Loans).
  • Step-down (declining) premium. A fixed percentage of the balance that falls over time. Fannie Mae’s published schedule for a five-year fixed-rate loan is 5-4-3-2-1, meaning 5% of the balance in year one, falling to 1% in year five (Fannie Mae Declining Prepayment Premium).

Prepayment terms matter most if you might sell or refinance before maturity. They are part of the cost of the loan.

Sources of permanent debt

  • Banks and credit unions. Often provide recourse or partial-recourse loans and may keep them on their own balance sheet.
  • Life insurance companies and pension funds. The OCC notes they often have long-term investment needs and favour fixed-rate terms of 10 years or longer.
  • CMBS (conduit) lenders. Loans are pooled and sold to investors as securities. They are commonly fixed-rate and non-recourse, with less flexibility once the loan is securitised.
  • Fannie Mae and Freddie Mac (multifamily). Both finance apartment properties through approved lender networks. Fannie Mae’s Delegated Underwriting and Servicing (DUS) lenders and Freddie Mac’s Optigo lenders originate the loans (Fannie Mae; Freddie Mac).
  • SBA programs (owner-occupied property only). See the next section.

SBA 504 and 7(a) for owner-occupied property

The U.S. Small Business Administration’s programs are for operating businesses buying or improving property they use, not for investors.

SBA 504 loans provide long-term, fixed-rate financing for major fixed assets such as buildings and land. They are made through Certified Development Companies (CDCs) working with a senior lender, offer 10-, 20- and 25-year maturities, and SBA states they cannot be used for “speculation or investment in rental real estate” (SBA 504 loans). The borrower must generally contribute at least 10% of project cost, rising to 15% for a business operating two years or less or a limited- or single-purpose building, and 20% where both apply (13 CFR 120.910).

SBA 7(a) loans can be used to acquire, refinance or improve real estate and buildings, among other purposes, with a maximum loan amount of $5 million (SBA 7(a) loans).

For both programs, occupancy rules apply. For an existing building, the business must occupy at least 51% of the rentable space; for new construction, at least 60% immediately, with further occupancy planned over time (13 CFR 120.131).

Underwriting metrics: DSCR, LTV and debt yield

Lenders typically size a loan as the smallest amount allowed by several tests. The OCC defines the three most common:

  • Debt service coverage ratio (DSCR): net operating income (NOI) divided by annual debt service. It measures the ability to pay.
  • Loan-to-value (LTV): the loan amount divided by the property’s market value.
  • Debt yield: NOI divided by the loan amount, as a percentage. The OCC says it measures risk independently of the interest rate, amortization period and capitalisation rate.

For banks, the federal agencies also publish supervisory LTV limits: for example, 80% for commercial and multifamily construction loans and 85% for improved property (12 CFR Part 365, Appendix A). These are supervisory guidelines for banks’ lending policies, not offers or market terms. Individual lenders often set lower limits.

Illustrative example (hypothetical numbers only)

All figures below are invented to show how the maths works. They are not market rates, values or lender terms.

Stage 1: the bridge loan. An investor buys a partly vacant building for $8,000,000 with a $6,000,000 interest-only bridge loan at a hypothetical 9% rate. Current NOI is $400,000.

Metric Calculation Result
LTV $6,000,000 ÷ $8,000,000 75%
Debt yield $400,000 ÷ $6,000,000 6.7%
Debt service $6,000,000 × 9% $540,000 a year
DSCR $400,000 ÷ $540,000 0.74x

A DSCR below 1.0x means income does not cover interest. That is why such a loan might need an interest reserve or sponsor cash, and why the business plan has to work.

Stage 2: refinancing into permanent debt. Assume a hypothetical permanent lender requires a maximum 65% LTV, a minimum 1.25x DSCR and a minimum 9% debt yield, using a hypothetical 6.5% rate with 30-year amortization (an annual payment of about 7.58% of the loan).

Scenario LTV test (65%) DSCR test (1.25x) Debt-yield test (9%) Maximum loan Repays $6.0m bridge?
Plan works: NOI $700,000, value $10.0m $6.50m $7.38m $7.78m $6.50m Yes
Plan slips: NOI $550,000, value $8.5m $5.53m $5.80m $6.11m $5.53m No: about $475,000 short

In the second scenario the owner would need to add equity, extend the bridge loan (if the conditions can be met), sell, or negotiate with the lender. This gap is what refinance risk looks like.

The regulatory backdrop for bank CRE lending

Two pieces of interagency guidance shape how banks approach commercial real estate:

  • CRE concentrations (2006). The OCC, Federal Reserve and FDIC set supervisory criteria to identify banks with significant CRE exposure, including construction and land loans of 100% or more of total capital, or total CRE loans of 300% or more of capital with 50% or more portfolio growth over 36 months. The agencies state these criteria are not limits on CRE lending (Federal Reserve).
  • Loan accommodations and workouts (2023). The OCC, Federal Reserve, FDIC and NCUA issued a policy statement encouraging prudent short-term accommodations and workouts with creditworthy borrowers. It says institutions that implement prudent arrangements after a comprehensive review of the borrower will not be criticised for doing so, and that loans to borrowers able to repay on reasonable terms will not be adversely classified solely because collateral value has fallen below the loan balance (FDIC FIL-34-2023).

For borrowers, this means a bank facing a maturing loan may be willing to discuss an extension or restructuring, but it will look closely at income, guarantor support and repayment ability.

Key risks

Refinance and maturity risk

The OCC notes that even borrowers who keep up with payments can struggle to refinance a balloon payment at maturity if property values decline. Bridge loans concentrate this risk because the term is short and the plan has to succeed in time.

Interest rate risk and rate caps

Floating-rate debt service rises when the benchmark rate rises. Floating-rate lenders may require an interest rate cap, a contract that pays out if the benchmark rate goes above a set strike rate, limiting the borrower’s exposure for the cap’s term. Freddie Mac, for example, offers floating-rate loans with a choice of rate cap coverage (Freddie Mac floating-rate loans). Caps cost money, expire, and may need to be replaced for an extension.

Leasing and execution risk

Renovations can run over budget, and lease-up can take longer or achieve lower rents than planned. The OCC also flags tenant credit and lease expirations as drivers of property performance.

Exit planning

Plan the exit before you close the bridge loan:

  1. Define the target. What NOI, occupancy and value must the property reach, and by when?
  2. Size the take-out. Run the permanent-loan tests (LTV, DSCR and debt yield) using conservative assumptions, as in the example above.
  3. Stress test. What if income is lower, rates are higher or the value is lower?
  4. Check the extension conditions and the cost of extending any rate cap.
  5. Keep a back-up plan. Additional equity, a sale, or a smaller refinance with a paydown.

Due diligence questions to ask a lender

  • What are the exact maturity date, extension options and extension conditions?
  • Is the loan recourse, partial recourse or non-recourse? What are the carve-outs, and which ones trigger full recourse?
  • Is there an interest reserve, and how is it funded and monitored?
  • What rate cap is required, for how long, and who must buy the replacement?
  • How are DSCR, LTV and debt yield tested during the loan, and what happens if a covenant is missed?
  • What are the prepayment terms: yield maintenance, defeasance, a step-down premium or an open period?
  • What fees apply at origination, extension and exit?
  • What reporting and cash management (for example, lockbox) requirements apply?
  • Can the loan be assumed by a buyer?

Have a qualified real estate attorney and accountant review the loan documents before signing.

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