When investing in real estate, there’s no single strategy that every investor should use. You have a diverse range of options that you can tap into as you attempt to build a successful real estate portfolio. One route you can explore involves applying for hard money loans that can help you get from one investment property to the next. These short-term loans are often obtained when selling and buying different properties. Here’s a comprehensive overview of what a hard money loan is and why you might want to apply for one.

What Are Hard Money Loans?

Hard money loans have been misused in recent years and are commonly applied as a blanket term for all non-QM loans. However, they have a more precise description that you should know about before investing in real estate. This type of loan is designed to bridge the gap between purchasing a new investment property and selling an existing one. Many investors pair a hard money loan with a 1031 exchange to avoid paying capital gains taxes for many years.

To understand how you can benefit from a hard money loan, let’s say that you want to sell an existing investment property and use the proceeds to buy another. Even if you’d like to sell your current property first, it doesn’t always work out this way. If you find the perfect property before you’ve sold your current one, you can’t just wait for someone to make an offer. In this scenario, your best bet is to use a hard money loan to help finance the purchase.

Hard money loans can be used to pay for closing costs and part of the property. You can apply for this loan with lenders that offer non-QM options. While terms can vary, borrowers are usually able to ask for up to 80% of their home’s price and the value of the property they want to buy.

Before you apply for this loan, remember that your current investment property will be used as collateral. If you don’t make your payments on time, the lender can take ownership of your property.

How to Calculate DSCR

When you’re trying to build a strong real estate portfolio that’s filled with successful investments, you’ll need to make the occasional calculation. The DSCR formula is straightforward. Simply divide the property’s annual gross rental income by its debt obligations.

You can determine the gross rental income by adding up the estimated monthly payments you expect to get from future tenants. Since you don’t yet own the property, you can set the appropriate monthly rental amount by looking at comparable properties near the one you’re interested in. Look at the rent prices for single-family homes that have similar features and square footage.

To make the calculation, add up your annual debt, including everything from HOA payments and the loan principal to taxes and insurance. You can now divide the gross rental income by your annual debt to find the ratio.

When applying for a DSCR Loan, you’ll quickly discover that every lender has its own requirements for the minimum ratio. A ratio of 1.0 means that you’re earning enough income each month to pay your debt obligations. However, lenders often want a DSCR of at least 1.2-1.25.

When to Apply for a Hard Money Loan

Hard Money Loans are popular with investors for many reasons. If you want to flip a house, you can use this short-term loan to get fast financing. Once you’ve repaired the property, you can sell it and repay the loan without needing to get a traditional mortgage. Since you’ll most likely repair the house and sell it within a year, you don’t need long-term financing.

This strategy is perfect for investors who have found their dream home and want to get cash fast to make an offer that will beat the competition. Hard Money Loans often have a much shorter approval process than traditional mortgages.

If you’ve found a great investment property but the seller won’t agree to a contingency that gives you time to sell your existing home, a hard money loan can get you the financing you need. The same is true if the closing date for your current investment property is set to occur after the new one.

Benefits of Obtaining a Hard Money Loan

Just like all loan types, hard money loans have their pros and cons. The main benefits include the following:

• You’re able to buy a new investment property before you’ve sold your current one
• You’ll have access to a short-term financing solution
• These loans may not have payments for a few months
• Some lenders allow borrowers to defer payments until they sell

What’s more, the approval process is fast and more lenient. If you want to buy the property quickly, a Hard Money Loan may be exactly what you need. Applying for a traditional mortgage can take over 30 days. Hard money loans can close in less than 10 days.

While Hard Money Loans offer plenty of advantages, you shouldn’t apply for one until you have all the facts. One potential downside is that many hard money lenders require 20% equity, which means that you’ll need to make a high down payment. Interest rates can also be high.

Applying for a Hard Money Loan

While qualifying for a hard money loan is easier than getting approved for a traditional mortgage, there are still a few requirements you’ll need to meet. Credit score guidelines are often flexible. Depending on the lender you apply with, you may even be able to qualify with a score of around 500. However, some lenders don’t accept applications unless credit scores are close to 700.

As mentioned before, you may need to make a 20% down payment when applying for a hard money loan. Some lenders require just 15%. As for the debt-to-income ratio, you could qualify for a loan with a ratio of up to 50%. Keep in mind that some lenders will require proof that you’ve listed an existing investment property for sale.You can determine the gross rental income by adding up the estimated monthly payments you expect to get from future tenants. Since you don’t yet own the property, you can set the appropriate monthly rental amount by looking at comparable properties near the one you’re interested in. Look at the rent prices for single-family homes that have similar features and square footage.

Budget for Your Closing Costs

All mortgage loans come with closing costs, which include administrative and legal fees. To make sure you’re fully prepared to apply for this type of loan, it’s a good idea to create a budget. Closing costs often range from 1%-3% of the total loan amount. All the costs you pay will be shown on the documentation you sign at closing. Some of the fees you may encounter include the following:

• Notary fee
• Loan origination fee
• Appraisal fee
• Escrow fees
• Title policy costs
• Administration fee

While a hard money loan may be right for you, you can’t be certain until you calculate your costs and determine what you can afford.

A hard money loan is a non-QM loan that you can apply for if you want to close fast or you can’t get approval for a traditional mortgage. If you’re looking to make an offer on another investment property, consider all your lending options to choose the type of loan that’s right for you. If you’d like to use a Hard Money Loan for your next investment property, get in touch with us today.