Are you considering getting a hard money loan on a rental property? These short-term loans may or may not be a good option depending your unique situation. You must consider several factors to determine if hard money financing is a good fit for your rental property.
What is a Hard Money Loan?
A hard money loan is a private money loan that is primarily based on real estate value and not the borrower’s creditworthiness. These loans generally have higher interest rates than institutional real estate financing but are significantly faster and easier to get.
Most of the time the term of a hard money loan is one year so they’re often referred to as “bridge loans” since they are not intended to be permanent financing. Hard money loans are interest-only loans meaning the principal is not paid down over the course of the loan.
Challenges of Rental Property Hard Money Loans
All hard money loans, including rental property hard money loans, have short terms, usually around one year. At that point, the loan becomes due and must be paid in full through refinance, sale of the property, or other means. If you want to hold onto the rental property, a hard money loan would not be your first choice because of the timeframe.
Additionally, hard money loans are interest-only, so there is no way to repay the loan over time through monthly payments.
For these two reasons, hard money is not the go-to option for rental property loans in a perfect world. But who says the world is perfect? Hard money rental property loans certainly have their place in ordinary, less-than-perfect circumstances.
Scenarios for Rental Property Hard Money Loans
In many ways, hard money loans are actually a good fit for rental properties: They’re non-owner-occupied loans, super-fast compared to bank financing, and primarily concerned with property value rather than cash flow (in case the property is vacant or under-leased). Also, hard money lenders love rental property loans because of their ability to service the debt.
Here are some scenarios where hard money is actually a good option for a rental property loan:
- The rental property needs a lot of work. Often, properties in poor condition won’t appraise for traditional financing. Hard money lenders have fewer constraints on valuing the property and can also fund needed improvements.
- The rental property is not leased or is under-leased. If you’ve been turned down for long-term loans because the DSCR (debt service coverage ratio) still needs to be met, then hard money can be a good bridge loan solution to give you time to re-lease the property and establish a DSCR suitable for long-term financing. While hard money lenders like to see good debt service coverage, it’s usually optional for a loan.
- Your credit could be better. Long-term rental property financing may be out of reach if you have credit issues. Hard money rental property loans are more concerned with property value than your creditworthiness. If you need financing now, a hard money loan can give you time to improve your score for permanent financing.
- You need fast financing. One of the benefits of hard money is that it’s super quick. If, for any reason, you need to purchase or refinance a rental property quickly, hard money is your best bet.
Pitfalls of Rental Property Hard Money Loans
When considering a hard money loan for a rental property, remember that these loans are meant to be temporary. They’re bridge loans to permanent financing only, and because of their higher interest rates, you wouldn’t want them to be permanent anyway. For this reason, you must have a viable exit strategy for refinancing or selling the property.
This exit strategy must be implemented on day one of the hard money loan. Do not wait until the loan is almost due to determine your plan! Time ticks quickly, and you’ll risk losing the property to foreclosure if you don’t have a sound exit strategy.
Here are some things to ask yourself regarding a hard money rental property loan:
- What are the details of the hard money loan? Is there a penalty for an early payoff? Is the lender collecting property tax in the monthly payment?
- Are you willing to accept higher interest payments in the short term? Will rent income cover interest payments and property tax? If not, where will that cash come from?
- Do you have a strategy for refinancing the property? What do you need to do to make this happen? Have you talked to your permanent lender?
- Are you willing to sell the property to pay off the loan? How long do you think it will take to sell? What do you have to do to prepare the property for sale?
Conclusion
Just like any financing, rental property hard money loans are tools. And like any tool, there are jobs they’re good at and jobs they aren’t. It all comes down to your unique real estate investment scenario. It’s a lot to sort through, but guess what? We’re here to help!
Little City Investments has provided rental property hard money loans in Texas for almost two decades. We’re a direct hard money lender and experts on what it takes to make these loans work. We’re happy to discuss your unique situation and determine what type of loan is best for your rental property.
Little City Investments is a Texas-based direct hard money lender. We specialize in rental property hard money loans, and we’ll get your deal done. Apply today!