The commercial real estate market is booming with plenty of opportunities for investors with different risk tolerances and investment goals. If you’re diving in, you are also probably exploring different sources of capital.
Commercial real estate hard money lenders can provide fast and flexible financing to acquire all kinds of CRE properties— especially those that traditional lenders tend to overlook or take longer to approve. Another financing option to consider is a Debt Service Coverage Ratio or DSCR loan, which is based on the property’s income-generating potential rather than your personal credit score.
In this blog, we zero in on these two types of CRE financing. We will talk about their key differences and how you can maximize them for your commercial property real estate investment.
Understanding hard money loans
A hard money loan is an asset-based, short-term financing secured using commercial real estate as collateral. Hard money lenders are typically private investor groups — not conventional banks. This loan focuses more on the property’s value rather than your creditworthiness. This is why it’s more accessible to CRE investors with less-than-stellar credit.
Terms and conditions to know when taking out a hard money loan
- Loan duration – Hard money loans are typically short-term, usually lasting from 6 months to 3 years. This aligns with the timeline of quick renovations or fix-and-flip projects, which are the types of CRE projects that typically use hard money financing.
- Interest rates – Interest rates often range from 9% to 12% for hard money. This is due to the higher risk and shorter duration of the financing.
- Loan-to-value (LTV) ratios – Most hard money lenders offer a maximum 75% loan-to-value ratio. This means you can take out a loan for 75% of a property’s value.
Benefits of hard money for CRE borrowers
Hard money loans are often the go-to options for most commercial real estate investors because they offer the following benefits:
- Faster approval times – One of the biggest perks of hard money loans is that they get approved quickly, meaning you can get the funding as soon as possible. It’s not uncommon to secure the money within a few days so you can take action on time-sensitive CRE investment opportunities.
- Credit requirements are less strict – In hard money loans, the property’s value is more important than your credit score as a borrower. This makes them easier to access even if your credit isn’t that great.
- Flexible terms and conditions – Hard money lenders offer more flexible conditions and terms compared to traditional banks. You may even be able to negotiate tailored deals that align with your investment requirements.
Ways to use a hard money loan
Hard money loans can be versatile for various applications:
- Fix-and-flips – If you’re investing in a property that needs to be renovated or repaired, a hard money loan can help you fulfill the necessary fixes and improvements so you can sell it for a profit. You can use the loan to cover the initial purchase and some (if not all) renovation costs.
- Bridge loans – A hard money loan can also serve as a commercial real estate bridge loan if you want to buy a new property before you sell another. For example, if you see a good CRE investment opportunity that requires immediate action but your current property is still on the market, you can use a hard money loan to buy the new CRE property while you wait for your existing property to sell.
- Construction and land financing – The availability of traditional financing for buying raw land or funding a new construction project tends to be limited. Hard money lenders are generally more open to funding such projects.
- Investment properties – Due to factors like occupancy issues or poor condition, some types of CRE properties may not qualify for traditional financing from banks. Hard money loans are more forgiving. You can use them to improve and renovate such properties to increase their rental or resale potential.
- Whenever you need quick access to funding – Hard money loans are perfect for any situation where you need quick access to sufficient capital. That makes them ideal for competitive real estate markets that require quick decision-making and access to funds.
What are Debt Service Coverage Ratio loans?
Debt Service Coverage Ratio or DSCR loans are based on the property’s generated income instead of your personal income.
To qualify for a DSCR loan, your property must generate enough income to cover the monthly payments (including principal and interest). Most lenders require a 1.25 DSCR or higher. This means your property’s income must be 25% higher than its debt obligations. That said, the number will vary depending on the lender, so it helps to compare the options.
DSCR terms and conditions
- Interest rate – DSCR loans typically have lower interest rates compared to what hard money lenders As of writing this, the current rates are from 7.2% to 8.7% APR.
- Duration – DSCR loans range from 10 to 30 years (similar to a conventional mortgage).
Advantages of DSCR loans
- Ideal for income-generating properties – DSCR loans are focused on the property’s income-generating potential instead of your personal credit, so they may be practical if you need funding for properties that can generate sufficient monthly income.
- Low interest rates – DSCR loans often have lower interest rates that minimize your overall costs.
- More predictable and stable – DSCR loans offer long-term stability and predictability with fixed interest rates and longer terms, making them ideal for long-term investments.
Applications of DSCR loans in commercial real estate
DSCR loans can be practical for commercial real estate properties with reliable and solid income streams and consistent tenants. Additionally, they may suit you if you want to finance long-term rental properties that produce stable incomes.
Choosing between hard money loans and DSCR loans
Compare interest rates.
Hard money loans typically have higher interest rates, ranging from 9% to 12%. This is due to their shorter terms and higher risk profile for lenders. In contrast, DSCR loans offer lower interest rates, usually between 7.2% and 8.70% APR. These rates are more comparable to traditional mortgages because lenders prioritize longer terms and income-generating properties.
The right choice really depends on your investment horizon. If you’re looking for financing for a short-term, high-risk-high-reward CRE deal, a hard money loan might be suitable. If your goal is to make a longer-term and more stable investment, a DSCR loan could be a better option.
Compare loan terms.
Hard money loans provide short-term financing typically lasting 6 months to 3 years, which matches the timeline of fix-and-flip CRE ventures. On the other hand, DSCR loans offer longer terms, ranging from 10 to 30 years, resulting in lower monthly payments and greater long-term stability.
Repayment schedules.
DSCR loans typically follow a standard amortization schedule, meaning you pay both principal and interest over the loan term. While this might result in higher monthly payments compared to interest-only loans, it offers a predictable and consistent repayment path.
On the other hand, hard money lenders often offer interest-only payment schedules. With this arrangement, you only pay the interest each month, and the principal balance remains the same until the loan matures. This can be beneficial if you need lower monthly payments during the early stages of a project.
How to apply for hard money loans and DSCR loans and their approval
Take the time to understand the application processes for both hard money loans and DSCR loans before you apply for either. Familiarize yourself with the lender’s criteria for approving loan applications, too.
Applying for hard money loans
- Pre-qualify: Share your basic financial information to help the lender assess your eligibility.
- Submit your application: Fill out their application form and submit it with the necessary documents, such as project timelines, cost estimates, and property plans. Hard money lenders often require fewer documents because they focus on your property’s potential and value.
- Financial and credit review: Lenders may look at your credit score, but their decision ultimately depends on your property’s investment potential and value. This allows them to approve investors in a matter of days.
- Property appraisal: The hard money lender may order an appraisal to verify the property’s value, ensuring it aligns with your financing needs.
- Approval: You will get a loan commitment with the terms and conditions of the financing.
- Closing: Sign the agreement so the lender can disburse the funds right away.
Applying for DSCR loans
- Pre-qualify: The lender will analyze your property’s income-generation potential. Moreover, they will ask for your financial records to verify revenue streams and rental income. DSCR lenders also require more extensive and comprehensive documentation, so be ready to show property performance reports, rental agreements, and income statements.
- Financial and credit review: The lender will assess your Debt Service Coverage Ratio, ensuring your property has at least 1.25 DSCR (though some lenders have lower requirements).
- Appraisal: Like hard money lenders, DSCR lenders want to verify your property’s income potential and value.
- Approval: If your property meets their criteria, the lender will issue a loan commitment. This could take some time because of the extensive financial scrutiny involved.
It’s generally easier and quicker to get hard money loans, making them ideal if you need fast access to capital. As mentioned, lenders are more stringent with DSCR loans because they want to ensure the property’s income-generating capacity. The comprehensive financial analysis can delay the approval process, making the loan ideal for long-term and stable investments.
Need financing advice?
Our team of private commercial real estate lenders at Private Capital Investors is ready to help you make an informed choice. Call us at 972-865-6206.
