NB: Access to rental (DSCR) loans will soon be available to find and compare on our platform, but we're not quite ready. We've still created this guide to help you, but if you need a rental loan now, contact us, and we can manually broker this loan for you — for free.
Over the past decade, a wave of short- and long-term rental investors has taken storm to make this the most popular form of investment property finance. Is a rental loan truly "hard money"? Well, arguably not, but most hard money lenders offer this financing to investors because it's easy for them to sell the loans onto Wall Street once they've closed.
This is the one loan type that you can get a similar product for at your bank. However, there are some key differences. First, traditional finance for investment properties is a far slower process than using a rental (DSCR) loan. Banks underwrite investment property loans the same way they do your mortgage, so they'll need to assess your W2 and tax returns and go through the same underwriting process.
By contrast, a rental loan from a hard money lender is a more streamlined process, with the same, lighter checks in place. It's faster, too: you should be able to get funding within around 30 days. However, there are a couple of downsides, which we'll cover below.
New investors often get into rentals thinking they can get the same 5% down product that they can get with their mortgage. This is, unfortunately, not the case. A hard money lender expects you to put 15-30% down on the property to get a loan, with most rental loans falling in the 20-25% range.
Remember, the remaining loan amount is only the "gross" amount; you'll need to deduct closing fees from the balance you'll receive.
DSCR (Discounted Service Coverage Ratio)
In addition, most rental loans have an additional check that can restrict the amount of funding you're eligible for, called the "discounted service coverage ratio." This term has become so ubiquitous in the industry that many lenders and investors call these products DSCR loans.
In short, DSCR asks whether you have enough net rental income to pay the interest on your loan. Then, it gives a ratio that you must meet, usually between 1 and 1.2. For example, suppose your rental income is $2,000 per month, you estimate you maintenance to cost $200/month, and you have to pay $150 in taxes, $100 in insurance and $100 in HOA fees per month. Your net rental income is then $1,450.
With a DSCR of 1.2x, the lender wants to know that you have 120% of the net rental income compared to your monthly interest cost. So if the interest on your loan is $1,100 per month, you'll be fine (DSCR = 1.32), but if the interest is $1,300 per month, your DSCR (= 1.16) is too low, and you'll need to reduce your loan amount or find another lender.
Even though it can be restrictive, this is a helpful check for investors. After all, if your net rental income can't meet the required ratio, this often means you'll be losing money— or at least close enough to make a poor investment decision.
With higher interest rates, we've found investors are finding it a lot harder to meet the DSCR requirements. However, one way to address this is to find investment properties that need renovation before renting out. You'll likely have a better chance of finding properties below market value, and the equity you add to the property will improve the health of your investment over time.
Vacant Properties
Suppose the rental property you buy or get funding for is vacant, and you can only line up a tenancy after closing. In that case, your financing is usually capped at 70% LTV (i.e., requiring a 30% downpayment). This also assumes the property is rentable in its current condition; if it requires significant work before renting, you'll need to get a short-term bridge or rehab loan before applying for longer-term finance.
Purchase vs. Refinance / Cash Out
You'll find the best terms for rentals you're purchasing ready-to-rent. However, if you've bought and rehabbed a property to rent out, you already own the property and will want to refinance or get cash out of the property you currently own. In this case, you usually need to take a 5% "haircut" for a refinance and a 10% "haircut" for cash out. This means the maximum leverage for refinances is 75-80%, depending on the lender, and 70-75% for cash-out properties.
Short-Term (or Medium-Term) Rentals
The above downpayment figures apply to long-term rental properties (i.e. with tenancies of 6 months or more). However, what if you're trying to get funding towards a short-term rental?
Many lenders, unfortunately, won't touch short-term rentals, but we work with lenders who do. If you're purchasing a property that has not been used as a short-term rental before, the most you can generally get for the property is 70% LTV. Once you have 6-12 months of AirBnB (or equivalent) data, 75-80% of products become available.
Versus Traditional Finance
The biggest upside of traditional finance is leverage. If you're in a great financial position and are not in a rush, it's often possible to get 85% financing, which most hard money lenders won't be able to do. However, you do sacrifice speed. So, this may be your way to go if you want to find 1 or 2 investment properties for a passive income boost. Hard money lenders will likely be a better partner if you want to scale and make a business from rental income.
The two most significant determinants of your finance costs are leverage and credit score. Most lenders work off a credit-leverage grid that determines your rate, usually between 7 and 8.5%. (These rates fluctuate as the U.S. 5-Year Treasury rates vary, which is what rental loan rates are loosely pegged to.) This does not include closing fees, which we cover in more detail in our Term Sheet Guide.
One tip to consider is not to max out on leverage, especially if your credit score is below 720. Lenders often have a big hike for the last 5% jump in leverage they're willing to provide. For example, suppose a lender has a 75% product for you at 8%, but their 80% product costs 8.75%. You're effectively paying a 20% interest rate for the marginal increase in funding, which you'll probably be losing money on. If you need help determining between your options, let us know!
Prepayment Penalty
The best rental loan terms are 30-year products. They can be repaid after five years, but any earlier than that, and you could face a hefty penalty. The lowest-cost loans come with a 5-5-5-5-5 penalty, which means you'll pay a 5% fee if you repay anytime within the first five months (even after four years and 11 months). A slight increase in your cost will get you a 5-4-3-2-1 penalty (i.e. your penalty goes down each year), and another bump can get you a 3-2-1 with most lenders (i.e. you only face a reducing penalty over your first three years). Finally, there are some 1-year or 0 penalty options, but these typically require a large cost increase.
If you're in a situation where you may need to sell your investment property in the near term, it may well be worth paying a slight premium to "upgrade" to a 3-2-1 penalty.
Like with the rest of investment property loans, two keys can determine whether you get a "yes" or a "no" from your hard money lender, and it's good to be aware of what they are.
Creditworthiness
A lender wants to know if you'll still be able to repay their loan, even if the proverbial hits the fan on your investment. To do this, they assess your creditworthiness. Most lenders want to know your FICO, how much cash you have to hand, and what assets you own. Unlike with a mortgage — where your application lives or dies by this information — this is more of a common sense check. Many smaller to mid-size lenders are willing to work with borrowers with sub-standard credit, especially if you can put more cash down or provide security on another asset.
However, gone are the days of lending purely based on the asset. Currently, around 70% of lenders on our platform do a hard credit check, whilst the remainder are happy to do a soft search.
Property Ease of Sale
The easier your property is to sell, the more likely it will be approved for a rental loan. This makes the location and asset type key to your application. Because rural properties are often harder to rent or sell — and harder to accurately price — lenders will either reduce the amount they'll lend or won't lend at all.
A rental loan from a hard money lender typically takes 30 days from application to close. It can be less — and we have lenders that can work fast if you need speed — but they still don't move as quickly as bridge loans. Likewise, the national lenders that are often the lowest cost normally have the slowest turnarounds, up to 45 days.
