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A Primer on Hard Money Long-term Rental Loan: What Is It & Why Should You Care

When it comes to real estate investing, financing plays a crucial role. Almost no one buys real estate with pure cash nowadays, so you will most likely need some sort of debt before you can close on that property you’ve been eyeing.

While traditional loans are the typical go-to loan for the single-family home buyer, not every loan applicant gets approved for a traditional loan. There are scenarios wherein you might even get denied for a traditional loan.

If you prefer, you can watch my video below. Otherwise, read on to know more about hard money loans.

Who Gets Denied For Traditional Loans?

Investors with a lot of existing loans. When you have a certain amount of loans outstanding, most banks don’t see it as a sign that you must be a good loan candidate. Instead, they see you as riskier and will deny you a loan.

Borrowers with a debt-to-income (DTI) ratio above 43%. When computing your DTI ratio, add up all your debt payments (mortgage, auto loan, insurance, taxes, association dues, etc.) and divide it by your gross income. Most banks impose a threshold of 43%. Anyone with a higher DTI will get declined.

Whatever the case may be, getting denied for a traditional loan isn’t the end. When conventional loans are no longer an option, this is where hard money loans step in.

What Is A Hard Money Loan?

Oftentimes considered as the “last resort” of the borrower, hard money loans are secured by real property. The way a hard money loan gets approved is the lender will take a look at the property’s debt-service coverage ratio (DSCR), which is the net operating income (NOI) divided by principal, interest, taxes, insurance, and association dues (PITIA).

The lender will lend you money based on whether that property can sustain itself through this mortgage. It doesn’t matter whether you have 10, 20, or 30 properties already. Of course, the loan amount you can get will vary as well.

How Much Can You Get From A Hard Money Loan?

You can get up to 75% of the purchase price of a new rental if it is move-in ready.

If the property needs some rehab work, then it would be better to buy it first with a traditional hard money loan or bridge loan then refinance out with a hard money long-term rental loan. With this loan, you’ll be able to leverage up to 70% of the appraised value of the property.

So while a hard money loan doesn’t look at your DTI, there are still some factors that are considered when applying for one.

What Matters To A Hard Money Lender?

A DSCR that’s above 1.15. Remember that the lender will look at the property’s DSCR. What matters to him is that the property’s NOI will be more than enough to cover the monthly payments.

If your DSCR is borderline at around 1, there is still a chance for you to get a hard money loan, but you’ll be charged 0.5% more on your rate.

A significant amount of rental income. If the property doesn’t meet that, you can use alternative renting methods like Airbnb or short-term rentals to satisfy the DSCR requirement, but you’ll be allowed to leverage only up to 60% of the appraised value.

Hard money loans tend to have higher interest rates than traditional loans. Don’t worry though as there are some levers you can pull to get a better rate for your property.

What Can Influence The Interest Rate On My Hard Money Loan?

As a real estate investor, you want to make sure you’re getting the lowest rates possible for your loan. To be able to do that, you need to be aware of the factors that can influence what interest rate you’ll get.

Your Loan-to-Value (LTV) Ratio

The maximum LTV you can get from a cash-out refinance is 70%. If you were to get a lower amount, say only 65%, your interest rate drops by 0.325%.

Now, if you decide to drop it further to 60%, your total rate decrease would be 0.625%

Your Credit score

A hard money lender will accept those with credit scores between 680-740. Anyone with a maximum credit score of 740 or above will get the best rates.

If your credit score is the minimum at 680, then you’ll get the highest rate. Those with borderline credit scores of 660-670 won’t automatically be disapproved. The lender might choose to have a talk to see if an exemption could be made.

Between 680 and 740 are multiple thresholds where a rate can change by 0.25%. Take note that the difference between the best rate and the lowest rate is about 0.625%. So you might want to consider finding ways to increase your credit score to reach the next threshold.

The Type of Property You Bought

The rate you get can vary too if you purchase a multi-family property versus a single-family residence. Whether you get a condominium unit or a townhouse will also affect your rate. It could increase by ⅛ of a percent or ¼ of a percent.

The Prepayment Penalty

Hard money loans usually come with a 3-year prepayment penalty. If for whatever reason, you pay off the loan before the prepayment penalty schedule is over, you will have to pay the prepayment penalty which is based on the loan amount.

The prepayment penalty follows a 3-2-1 drop.

If you pay off the loan in year one, you’ll pay a penalty of 3%.
If you pay off in year two, you’ll pay a penalty of 2%.
if you pay off in year 3, the penalty will be 1%.

After the third year, there are no more fees.

You can use the prepayment penalty to your benefit. If you’re willing to opt in for a 5-year prepayment penalty, you can lower your rate by 0.125%. Take note though that the prepayment penalty will follow a 5-4-3-2-1 schedule.

What if you want a shorter prepayment penalty? That’s possible too, but be prepared to have your rate increase by 0.25% for every year you don’t want a prepayment penalty for.

Unfortunately, with the current global economic conditions, hard money lenders will impose a 1-year prepayment penalty as the minimum.

Doing a Cash-out Refinance

If you had a loan before and you refinanced it to a hard money long-term rental loan, then the lender will charge you a bit more. Let’s say, you want cash on hand, then the lender will charge about 0.5%.

In another case, if your loan is under $100,000, then your rate could also go up by about 0.25%.

Important: The numbers and rates quoted above are valid as of August 2020. Don’t be surprised if the rates differ in the future as it could be higher or lower. It’s best to schedule a call with me and get the latest rates.

Are Interest Rates Fixed?

A hard money long-term rental loan is a 30-year loan, so there are different rate plans that you could take.

The 30-year fixed plan. This gives you a fixed interest rate for the duration of the loan, but it will be the most expensive.

Or you can opt for the 7-1 arm. With this, the first 7 years have a fixed interest rate then after that, the rate every year can adjust depending on some index.

For those looking for the cheapest option, the 5-1 arm is your choice. For the first 5 years, you’ll pay a fixed rate then every year after that, the rate can adjust based on some index.

While it’s true that hard money loans are more expensive than traditional ones, for investors who have a lot of debt, this could be a great solution so that you can continue buying properties even if you aren’t able to get another traditional loan.