DSCR vs. Hard Money Loans: Which Financing Fits the Deal?

DSCR vs. Hard Money Loans: Which Financing Fits the Deal?

Real estate investors have more financing options than a traditional mortgage.

Two of the most common alternatives are DSCR loans and hard money loans.

Both can be used to finance investment real estate, but they are generally designed for different types of properties, transactions and investment strategies.

A DSCR loan may make sense for a stabilized rental property producing income. Hard money financing may be used when an investor needs shorter-term financing for an acquisition, renovation, bridge transaction or property that isn't yet stabilized.

Understanding the differences can help an investor determine which financing structure may better fit a particular deal.

What Is a DSCR Loan?

A DSCR loan is investment-property financing that focuses primarily on the property's qualifying rental income and applicable housing expense rather than traditional personal income documentation.

DSCR stands for Debt Service Coverage Ratio.

A simplified calculation is:

DSCR = Qualifying Monthly Rental Income ÷ Applicable Monthly Housing Expense

For example, if a property's qualifying monthly rental income is $4,000 and its applicable monthly housing expense is $3,200:

$4,000 ÷ $3,200 = 1.25 DSCR

The exact calculation and expenses included vary by loan program.

DSCR financing is generally associated with rental and income-producing investment properties.

What Is a Hard Money Loan?

A hard money loan is generally short-term, real estate-secured financing used for qualifying business-purpose transactions.

Rather than focusing primarily on traditional personal income documentation, a private or hard money lender may place greater emphasis on the property, borrower equity and overall investment strategy.

Depending on the transaction, underwriting may consider:

• Property value
• Purchase price
• Loan-to-value
• Borrower contribution
• Property condition
• Renovation scope
• Investor experience
• Credit profile
• Liquidity and reserves
• Exit strategy

Hard money financing still involves underwriting, and exact requirements vary by lender and transaction.

What Is the Biggest Difference Between DSCR and Hard Money Loans?

One of the biggest differences is the stage of the investment each financing structure commonly serves.

DSCR financing is generally designed for rental properties where qualifying rental income can be evaluated as part of the loan.

Hard money financing is commonly used when a property or transaction requires shorter-term capital, particularly during acquisition, renovation, repositioning or another transitional stage.

An investor may therefore use both types of financing during the life of the same investment.

When Might a DSCR Loan Make Sense?

DSCR financing may be worth exploring when an investor owns or is acquiring a qualifying rental property that is already producing income or can otherwise meet the applicable rental-income requirements.

Common scenarios may include:

• Purchasing a stabilized rental property
• Refinancing an existing rental property
• Cash-out refinancing a qualifying investment property
• Building or expanding a rental portfolio
• Refinancing short-term financing after a property is stabilized

Depending on the program, qualification may also consider credit, property value, leverage, liquidity, reserves and other borrower or property characteristics.

When Might a Hard Money Loan Make Sense?

Hard money financing may be useful when the transaction doesn't yet fit longer-term rental-property financing or when the investor's strategy requires short-term capital.

Common situations can include:

• Fix-and-flip acquisitions
• Properties requiring substantial renovation
• Bridge transactions
• Time-sensitive investment acquisitions
• Property repositioning
• Short-term investment financing
• Transactions that don't fit traditional lending guidelines

The financing structure should match the investor's business plan and realistic exit strategy.

What About Property Condition?

Property condition can be an important distinction between these financing strategies.

A completed rental property in rentable condition may be a potential candidate for DSCR financing if it satisfies the applicable program requirements.

A property requiring significant renovation before it can be rented, sold or refinanced may be better suited to a short-term private financing structure during that stage of the project.

Once renovations are completed and the property is stabilized, the financing options may change.

Can You Go From a Hard Money Loan to a DSCR Loan?

Potentially, yes.

This can be a common real estate investment strategy.

An investor might:

1. Acquire a property using hard money or other short-term financing.
2. Complete the planned renovations.
3. Rent and stabilize the property.
4. Explore refinancing into longer-term DSCR financing.

This type of strategy is sometimes associated with investors who acquire, renovate and retain properties as rentals rather than selling immediately after renovation.

However, investors should evaluate the anticipated refinance requirements before entering the initial short-term loan.

A future DSCR refinance is not guaranteed simply because the renovation is completed.

How Does the Exit Strategy Differ?

The exit strategy can be particularly important with hard money financing because these loans are commonly intended to be short-term.

A hard money loan may be repaid through:

• Sale of the renovated property
• Refinancing into DSCR financing
• Refinancing into another longer-term investment loan
• Another approved repayment strategy

With DSCR financing, the investor may instead intend to hold the property as a longer-term rental investment, subject to the terms of the particular loan.

Is Hard Money Financing Faster Than DSCR Financing?

Private lenders may sometimes accommodate transactions requiring a streamlined or flexible underwriting process, but there is no universal closing timeline for either type of financing.

Closing time can depend on factors including:

• Property valuation
• Title
• Insurance
• Borrower documentation
• Entity documentation
• Property condition
• Loan structure
• Transaction complexity

Investors facing a time-sensitive acquisition should provide complete information as early as possible.

Which Loan Has More Flexible Property Requirements?

The answer depends on the lender and loan program.

Hard money financing is often used for properties undergoing renovation, repositioning or another transitional stage.

DSCR financing is generally associated with properties intended to function as rental investments and must meet the applicable property and program requirements.

Rather than assuming one program is more flexible overall, investors should evaluate flexibility in the context of the specific property and transaction.

DSCR vs. Hard Money: Questions to Ask

Instead of starting with a loan product, investors can start with the deal.

Consider these questions:

• Is the property currently producing rental income?
• Does the property require substantial renovation?
• How long do you plan to own the property?
• Are you planning to sell or retain it as a rental?
• How quickly does the transaction need to close?
• How much capital are you contributing?
• What is the realistic exit strategy?

The answers can help determine which financing structures are worth evaluating.

Financing California Real Estate Investments

Xcel Funding LLC is a California Finance Lender providing business-purpose real estate financing for investors, developers and property owners throughout California.

Financing options include DSCR, hard money, fix-and-flip, bridge, construction and other real estate-secured business-purpose loans.

If you're evaluating a California real estate investment, start with the property and the investment strategy rather than simply choosing a loan product.

Be prepared to discuss the property, purchase price or value, requested loan amount, property condition, expected rental income if applicable, project timeline and exit strategy.

Those details can help determine which potential financing structures fit the transaction.

Program availability, terms and qualification requirements vary by transaction.

Xcel Funding LLC | California Finance Lender Lic. #60DBO-202689

About the Author

Brian Paris is CEO & Principal of Xcel Funding LLC, a California Finance Lender providing business-purpose real estate financing for investors, developers and property owners throughout California. His experience spans real estate investing, mortgage lending and private real estate financing.

Xcel Funding LLC | California Finance Lender Lic. #60DBO-202689