Now, you’ve decided that the world of real estate investment is one that you want to tackle. However, before you are ready to go searching for properties, it is important to ensure that you get the proper financing for the acquisition of the property.
Two loan options often come up for investment properties: these are DSCR loans and hard money loans. They both target the investors, but they differ in some aspects that can exponentially affect your investments. Now, let’s look at DSCR loans vs. Hard money loans to figure out which of them will work best for you.
Why DSCR Loans?
DSCR loans are characterized by particular attention to the income that the property is likely to generate and not the borrower’s income. This is good news for investors who have little personal income or whose personal income structure is rather complicated. Here’s what defines DSCR loans:
Focus on Property’s Cash Flow: Lenders consider a property’s Debt Service Coverage Ratio (DSCR) to evaluate its affordability. This ratio expresses the subject property’s net operating income (NOI) to the total amount of principal and interest on the loan offered. A DSCR of 1.25 or higher is typically required, meaning the property’s NOI should cover at least 125% of the debt obligations.
Qualifying with Lower Credit Scores: However, as with any form of financing, those with good credit are generally more favored, but DSCR loans tend to permit lower credit scores than conventional mortgages. This means that investment opportunities are open for individuals who have a bad credit rating.
Longer Loan Terms: Conventional DSCR loans, on the other hand, more often have longer loan horizons; they range from 15 to 30 years on average. This leads to reduced monthly installments – your cash flow is higher, and hence, the returns on your investment might even go up.
Benefits of DSCR Loans
- Focus on property’s potential: Individual considerations are secondary as liquidity dominates the scene, with strong cash flow properties at the forefront.
- Lower monthly payments: This is an advantage because they reduce pressure on your cash flow as you pay off your loans over a longer period.
- Stable financing: In this case, interest rates are fixed over the loan period which means stability when it comes to the investment plan.
- More flexible credit requirements: Credit score requirements for the loan are comparatively less stringent than other conventional loans.
Drawbacks of DSCR Loans
- Stricter property qualification: The reality is that the property it refers to must show stable and dependable income potential.
- Higher down payments: It is important to note that DSCR loans tend to require a higher down payment than traditional loans.
- Potentially higher interest rates: The interest rates on DSCR loans could be a little high in comparison with normal mortgage loans.
Hard Money Loans: A Faster Alternative Option
Hard money loans give another type of funding for those cases where mainstream financiers could probably hold back. Here’s what to know about hard money loans:
Fast Funding: The most significant aspect of hard money lenders is the fact that they can fund very fast and are very flexible. This focuses more on the value of the property and the borrower’s experience as opposed to their credit scores. Thus, loans are approved within a short timeframe.
Ideal for Fix-and-Flip Properties: Another vital characteristic of hard money loans is that they are short-term financial solutions that range from 6 to 18 months, which makes them suitable for investors who are likely to flip the property they are funding.
Higher Interest Rates: Expect substandard interest compared to the one offered by DSCR loans or regular mortgages. This shows that more risk is involved on the side of the lender than on the borrower.
Benefits of Hard Money Loans
- Fast funding: Ideal when a company needs funds urgently for a business deal that requires immediate attention.
- Less stringent credit requirements: It might be useful for borrowers with low credit scores or credit histories that other lenders would consider as high risk.
- Flexible for niche projects: It is, however, crucial to understand that hard money loans are more versatile as they can fund such properties that require some work.
Drawbacks of Hard Money Loans
- High interest rates: Be prepared to work with high interest rates when dealing with a hard money lender because of the opportunities to get funding fast without numerous documents.
- Short loan terms: The short repayment period puts pressure on them to sell the property so that they can clear the loan balance.
- Higher closing costs: The costs of a hard money loan are slightly higher than the closing cost of conventional financing.
Application Process For DSCR And Hard Money Loans
DSCR Loan Application Process
Step-by-step guide on applying for a DSCR loan:
- Assess Property’s Income Potential:
- Determine the Debt Service Coverage Ratio (DSCR) by dividing the property’s net operating income (NOI) by its total debt obligations (principal and interest).
- Prepare Required Documentation:
- Property Financials: Include rent rolls, lease agreements, and profit and loss statements.
- Personal Financials: Provide bank statements and tax returns (although less critical than property financials).
- Credit Report: Obtain a recent credit report to check your credit score.
- Appraisal Report: Get a professional appraisal of the property to determine its value.
- Choose a Lender:
- Research and compare lenders specializing in DSCR loans.
- Evaluate their interest rates, loan terms, and eligibility requirements.
- Submit Loan Application:
- Complete the lender’s application form with detailed information about the property and your financial situation.
- Attach the required documentation.
- Underwriting and Approval:
- The lender reviews the application, focusing on the DSCR and property’s cash flow.
- They may ask for additional information or clarification.
- Loan Terms and Closing:
- Upon approval, review and negotiate the loan terms.
- Sign the loan agreement and complete the closing process, which includes paying any closing costs and fees.
Typical Timelines:
- Initial Assessment and Documentation: 1-2 weeks
- Lender Selection and Application Submission: 1 week
- Underwriting and Approval: 2-4 weeks
- Closing: 1-2 weeks
- Total Time: Approximately 5-9 weeks.
Hard Money Loan Application Process
Step-by-step guide on applying for a hard money loan:
- Identify a Suitable Property:
- Select a property that can be swiftly renovated and sold, making sure it complies with the lender’s investment property requirements.
- Prepare Required Documentation:
- Property Details: Include the purchase contract, property photos, and any inspection reports.
- Renovation Plan: Provide a detailed plan and budget for the renovations.
- Borrower Information: Supply personal financial statements, proof of funds, and previous real estate investment experience.
- Exit Strategy: Detail your plan for repaying the loan, which is usually achieved by selling or refinancing the property.
- Choose a Hard Money Lender:
- Research lenders who specialize in hard money loans.
- Compare their terms, interest rates, and loan-to-value (LTV) ratios.
- Submit Loan Application:
- Fill out the lender’s application form with comprehensive details about the property and renovation plans.
- Attach all required documentation.
- Underwriting and Approval:
- The lender evaluates the property’s value and your experience.
- They may conduct a property inspection.
- Loan Terms and Closing:
- Upon approval, review and negotiate the loan terms, including interest rates and fees.
- Sign the loan agreement and finalize the closing process promptly, often within a few days.
Typical Timelines:
- Initial Property Evaluation and Documentation: 1 week
- Lender Selection and Application Submission: 1 week
- Underwriting and Approval: 1-2 weeks
- Closing: 1 week
- Total Time: Approximately 3-5 weeks
Comparison Of DSCR And Hard Money Loans
Loan Terms and Conditions
| Feature | DSCR Loans | Hard Money Loans |
| Interest Rates | 7.5% to 9.5% | 10% to 15% |
| Loan Durations | 15 to 30 years | 6 to 18 months |
| Payment Structures | Fixed monthly payments | Interest-only with a balloon payment at the end |
Qualification Criteria
| Criteria | DSCR Loans | Hard Money Loans |
| Credit Score | Minimum 620 | More flexible, often accepting lower scores |
| Property Evaluation | Focus on DSCR (typically at least 1.25) | Emphasis on current and potential property value |
| Borrower Experience | Considers credit history and real estate experience | Strong preference for experienced investors |
Funding Speed
| Aspect | DSCR Loans | Hard Money Loans |
| Time To Secure Funding | 5 to 9 weeks | 3 to 5 weeks |
| Ideal Use Cases | Long-term investments with stable income potential | Fix-and-flip projects and urgent funding needs |
Making the Right Choice: DSCR vs. Hard Money
Ultimately, the best choice between DSCR loans and hard money loans depends on your specific investment goals and property type:
| Scenario | DSCR Loans | Hard Money Loans |
| Strong Investment Property with Steady Income | ✔ | ✖ |
| Quick Capital Needed for Immediate Opportunity | ✖ | ✔ |
| Long-Term Financing Stability | ✔ | ✖ |
| Fix-and-Flip Projects | ✖ | ✔ |
| Lower Credit Score Borrowers | ✔ | ✔ |
Choose a DSCR loan if:
- You are in a strong investment property position with steady revenue and secure income.
- You opt for long-term, fixed, and stable sources of financing with a stable level of interest.
- Your credit rating is average, but you have a sound investment strategy.
Choose a hard money loan if:
- You require quick money to capitalize on an opportunity that may only present itself for a short duration.
- You are to undertake a fix-and-flip operation with considerable rehabilitation tasks within an already existing home.
- You record a lower credit score
Now You Know! Deciding on the Best Loan for You
So, you’ve learned about DSCR loans and hard money loans! Now it’s time to decide which is right for you.
Consider the type of property you want to invest in. Are you interested in a long-term rental that generates consistent income, or are you looking to renovate and sell a house quickly for a profit?
Also, consider your financial situation. Do you have good credit and are you looking for a stable loan with a lower interest rate? Or maybe you have a lower credit score and need money quickly?
After evaluating these factors, you can select the loan that aligns best with your requirements.
If you’re still not sure, don’t worry! Connect with us. We can help you understand your options and make the best decision for your investment goals.
