Even though rent increases in the multifamily market have slowed down from their rapid pace in 2021 and 2022, there are still plenty of renovation and resale opportunities in this CRE segment — and you’ll need capital to take advantage of them. Using external funding is often the most efficient way to secure that capital. Should you use a hard money loan or a DSCR loan? Let’s explore the differences between these financing options.
Hard money loans for CRE: What you need to know
Hard money loans are asset-backed short-term loans offered by private lenders or investor groups. Unlike traditional bank loans, these financing solutions prioritize the value of the property instead of your credit score as a borrower.
Critical characteristics of hard money loans for commercial properties
To compensate for the higher risk, lenders take on hard money loans, which come with higher interest rates—often between 9% and 12%. However, it’s possible to get interest rates as low as 5.99% here at Private Capital Investors.
These short-term loans, usually six months to 3 years, are ideal for real estate projects with a defined timeline (such as rehabs and quick resales).
Lenders typically offer up to 75% of the property’s value, although we offer up to 85% here at Private Capital Investors.
Benefits of CRE hard money loans
- Hard money loans are processed and approved quickly, often within days, so you can seize time-sensitive CRE investment opportunities without delays.
These loans also allow flexibility in structuring the deal. Good lenders will tailor the financing to fit your project’s needs (as we do here at Private Capital Investors).
Since a hard money loan focuses on the property’s value, it’s an option even if your credit score isn’t perfect.
When should you use hard money loans for CRE?
- These loans are well-suited for fix-and-flip projects. If you plan to purchase a multifamily property and then renovate and resell it quickly, a hard money loan might be a good choice.
- A hard money loan also works well for projects with a shorter timeline because it can provide you with the necessary capital without long-term commitments.
- Do you need to act swiftly in a fast-moving market? These loans are approved and released much faster than traditional loans.
What is a DSCR loan?
A DSCR or Debt Service Coverage Ratio loan focuses on the income generated by the property itself rather than your income as a borrower. As you probably already know, the DSCR is a key CRE metric that evaluates a property’s ability to meet its debt obligations.
Critical characteristics of DSCR loans for commercial properties
DSCR loans are structured for 10 to 30 years (the same as standard mortgage terms).
These loans generally offer lower interest rates than hard money loans, so they may be more affordable for borrowers seeking longer-term financing.
To qualify, the property must generate sufficient income to cover its debt service. Exact requirements vary depending on the lender, but most look for a DSCR of 1.25 or higher — meaning the property’s income should be at least 25% greater than its debt obligations.
What are the benefits of DSCR loans for CRE?
- Unlike many traditional loans, DSCR loans focus on the income the property generates — not the borrower’s creditworthiness.
- Because of their extended loan durations, DSCR loans provide stable monthly payments and offer predictability for CRE investors looking to hold onto properties for longer.
When should you use a DSCR loan?
- DSCR loans are an excellent fit for financing rental properties that consistently generate income.
- They also work well for commercial properties with stable tenants and reliable revenue streams.
Hard money loans vs DSCR loans
Let’s compare a hard money loan vs a DSCR loan regarding interest rates, loan terms, repayment schedules, and application processes.
Interest rate comparison
Interest rates for hard money loans are higher, reflecting these financing solutions’ added risk and shorter duration. DSCR loans offer lower interest rates and are closer to those of traditional mortgages.
Loan term comparison
A hard money loan is designed for short-term use (6 months to 3 years), so they’re best suited for fix-and-flip investments. In contrast, DSCR loans offer long-term durations of 10 to 30 years.
Repayment schedules
Most hard money loans feature interest-only repayment schedules during the loan term, with the principal paid off at the end. By minimizing monthly payments in the short term, a hard money loan structure can be helpful for investors who need cash flow for project expenses.
DSCR loans follow a standard amortization schedule (both interest and principal are paid over the life of the loan). This means your monthly payments will be higher, but it also offers a clear repayment plan that gradually reduces the loan balance.
Application process and approval
The process for obtaining a hard money loan vs a DSCR loan differs in speed, required documentation, and approval criteria. Here’s a quick look:
Arduous money loan application process for CRE
- Hard money lenders start by assessing the project’s basic financial details. You’ll be asked to submit property plans, cost estimates, timelines, and other documents. The requirements are less extensive than traditional loans.
- Your credit score may be reviewed, but the primary focus is still on the property’s value and potential. This leads to faster decisions (often within days).
- The lender may conduct an independent appraisal to confirm that the property’s value justifies the loan amount.
- If your application for a hard money loan is approved, you’ll receive a loan commitment with tailored terms.
Finally, you sign the loan agreement, and the funds are disbursed.
DSCR loan application process for CRE
- Lenders will conduct an in-depth analysis of the property’s income potential. You must submit detailed financial records showing consistent rental income or other revenue.
- You must also provide income statements, rental agreements, and property performance reports. The process is much more documentation-heavy than hard money loans.
- Lenders will analyze the DSCR to ensure the property generates enough income to cover debt obligations.
- An appraisal is conducted to verify both the property’s value and its income potential.
- Once the property meets the lender’s criteria, they will commit to a loan. Note that the approval process takes longer because of the detailed financial scrutiny.
As you can see, a hard money loan is faster and easier to obtain. The approval process for DSCR loans is a lot more detailed.
Does a hard money loan offer more flexibility than a DSCR loan?
Hard money loans can be customized to align with your project’s needs. For example, you and the lender can agree on interest-only payments or customized repayment schedules to match your cash flow and timeline.
The terms and conditions of these loans can also be changed if your project shifts. Perhaps you need to adjust draw schedules, modify repayment terms, or extend the loan duration — all this is possible because these characteristics make a hard money loan a good choice for fix-and-flip projects.
In contrast, DSCR loans are a lot more rigid. They require extensive income verification and a high DSCR ratio, so they’re unsuitable for CRE investors whose multifamily properties must meet these income thresholds. These loans are most valuable for income-generating properties like established rentals. The application and approval process is much more detailed, making DSCR financing unsuitable if you require quick capital.
Return potential of hard money vs DSCR loans.
Both types of loans can deliver strong returns, but their strengths lie in different areas.
Hard money loans are designed for high-yield renovate-and-sell investments. If you know what you’re doing, you can use this type of financing to generate impressive profit margins quickly.
Meanwhile, DSCR loans are best for income-generating CRE properties you plan to hold on to for a long time because of their lower interest rates and long-term stability.
Risks vs. reward potential of hard money vs. DSCR loans
You need to understand the risk factors of both loan types to make the right choice for your project.
The high interest rates of hard money loans increase the cost of borrowing, so before you take out this type of loan, be sure that your project’s potential returns outweigh these higher costs.
Because these last six months to 3 years, you need to be able to complete and sell your project within this timeframe to avoid refinancing or facing default.
The success of hard money loans relies heavily on market conditions. A sudden downturn in the CRE industry can impact your property’s resale value and your project’s overall profitability.
Of course, DSCR loans have risks, too. These loans hinge on the property’s ability to generate income, so any disruptions (such as vacancies or drops in rental rates) can affect your ability to repay the loan.
The high DSCR ratio and detailed income verification required can also make it harder to qualify. Although DSCR loans provide stability, shifts in rental demand or property values can still impact the long-term performance of your investment.
Conclusion
If you’re looking for flexible and fast financing for your CRE projects, hard money loans might be the right fit. We offer these financing solutions here with our team of private commercial real estate lenders at Private Capital Investors. Find out more here.
