A “hard money loan” sounds scary to industry outsiders — like the kind of loan where the debt collectors show up with baseball bats. How did that money get so hard? Did it spend time in prison?

Real estate investors, of course, know that there is nothing shady or inherently dangerous about a hard money loan. It’s simply an aggressive name for a well-respected and accepted mainstream real estate loan. For beginners in the fix-and-flip or rehab space, hard money lenders are an attractive option for their speed, flexible underwriting, and willingness to finance rehab expenses.

‍

But after real estate investors get a few deals under their belt, hard money loans might start to look a little more scary — as in scary-high costs of borrowing. How fast can an honest investor scale when stuck paying up to 15% interest rates, up to 5 origination points, and a slew of junk fees? You can understand their motivation to find a hard money alternative.

‍

Munoz Ghezlan Capital has helped dozens of real estate investors escape the high-borrowing-cost cycle of hard money loans, educating them on alternative loans and matching them to willing and appropriate lenders. Let’s explore three of the most popular alternatives to hard money loans.

‍

Key Takeaways

• Hard money loans help many real estate investors get started. They often fund quickly, will loan rehab costs, but come with a high cost of borrowing — 10-15% APR, high origination fees and junk fees — and are short-term by nature with strict draw schedules and limits on how many loans you can take out.

• A DSCR loan is a long-term mortgage loan for investment properties based on the income potential of the property. They have lower interest rates and closing costs, can fund more quickly than conventional mortgages, and put no limit on how many loans you can secure. Ideal for Airbnbs, BRRRR, and long-term rentals.

• A business working capital loan is a type of business loan, often unsecured, based on business revenue and longevity in business. Perfect for adding a liquidity cushion or securing better contractor terms with early payment during a rehab or fix-and-flip.

• Private money loans are loans from individuals instead of institutions. Based on relationships, they can fund quickly with little documentation for trusted borrowers at whatever terms the parties agree to.

‍

What Are Hard Money Loans?

A hard money loan is a type of mortgage intended not for homeownership but for real estate entrepreneurship. They are popular for:

‍

• Fix-and-flip investors
• BRRRR investors
• Wholesalers
• Small-scale real estate developers

‍

What Are the Benefits of Hard Money Loans?

Hard money loans are attractive to real estate investors for a variety of reasons, including:

‍

• Fast Funding. Whereas a conventional homeownership mortgage takes 30-45 days (or even longer) for approval and funding, a hard money loan can fund in as little as 5-10 days if everything is in order. This speed might make or break a deal if the investor is bidding on the property at auction or trying to help a distressed seller avoid a foreclosure hearing scheduled within the month.

‍

• Rehab Financing Available. Whereas conventional homeownership mortgages use a “loan-to-value” (LTV) ratio to determine how much they are willing to lend, hard money lenders typically base their loan limits on the “loan-to-cost” (LTC) ratio — in other words, a percentage of the purchase price plus rehab costs based on the lender’s business plan and exit strategy. This means they will lend a portion of the rehab budget — sometimes much or even all of the rehab budget.

‍

• Based on the Value of the Property. Conventional home loans base their approval on the employment, income, and debt-to-income ratio of the borrower. By contrast, hard money loans depend more on the value of the property and the soundness of the investor’s business strategy. This makes it ideal for lower-income beginners, as well as career real estate investors, who tend to have erratic income and take many tax deductions.

‍

• Flexible Qualification. Because they don’t have to check the boxes of Fannie Mae/Freddie Mac guidelines, hard money lenders have the freedom to evaluate each deal individually, based on the investor’s business plan. 

‍

Why Would An Investor Want a Hard-Money Alternative?

This all sounds gravy … so why go on the hunt for a hard money alternative? As any investor who has used them will know, hard money loans carry with them some significant downsides, including:

‍

• High Cost of Borrowing. This reason sits atop all the others. Hard money loans are expensive. The standard interest rates alone make your average borrower blanche — 10%-15% APR without breaking a sweat. Add onto that 2 to 5 origination points, junk fees, and extension fees if the project exceeds the term of the loan (more on that below), and the cash flow pressure can start to become very real. For a good-enough deal, an investor can certainly come out ahead … but try not to think about how much further ahead you would come with lower borrowing costs.

‍

• Short Terms. By design, hard money loans are short-term. In contrast to a 30-year mortgage or 5-7 year business loan, the most common hard money loan term is 6-12 months. If your project takes longer, you may owe hefty fees to extend the term of the loan. The point is for you to use the hard money loan to acquire the deal and then refinance into a more permanent loan. If a conventional mortgage is still off the table due to income or employment reasons, within the year the borrower is going to be on the hunt for a hard money alternative no matter what.  

‍

• Strict Draw Schedules and Inspections. While hard money lenders will lend against the rehab, they almost never simply hand over the money up front. They require inspections, proof of work completed, and sometimes time horizons before they will release funds earmarked for the rehab to make sure you don’t simply pocket the money and get on a plane to Vegas. But what if a favorable contractor bid requires payment up-front or immediately? What if unexpected repairs arise or the investor needs fast liquidity? The draw schedule and inspection requirement could emerge as a serious bottleneck on the project. 

‍

• “Skin-In-The-Game” Requirements. As an investor gains experience and builds a relationship with the lender, hard money lenders might start to offer better terms. However, nearly every hard money loan requires the borrower to have substantial “skin in the game” — 10-20% down payments, cash reserves for rehab expenses, high closing costs, and high cash-to-close. These high cash requirements may put even hard money loans out of reach of cash-poor or beginner investors.

‍

• Not Always “Fast.” While hard money loans fund faster than conventional loans, they don’t always fund “fast enough.” For a variety of reasons (missing docs, delayed appraisal, etc.) the approval process could drag out to 7-21 days or longer. 

‍

• Rejection For Reasons Outside of the Investor’s Control. Many factors in the approval of a hard money loan are outside of your control. The appraisal could come in low. The lender could perceive more risk in the market than you do. You could have insufficient experience for the lender’s comfort. The lender may decide your rehab budget is too high … or too low! 

‍

• Roadblocks to Scaling. Hard money lenders do not have an infinite tolerance for lending to the same person. Investors attempting to run multiple projects at once will find hard money lenders putting a cap on the number of loans they will tolerate one investor to have in play. Even if they will continue lending, the cash-flow pressure from those high interest rates can limit the number of deals an investor feels comfortable taking down. 

‍

• Full-Doc or Near-Doc Underwriting. While hard money loans don’t depend on the borrower's personal income or employment, they aren’t “no-doc” loans. They require a large volume of documentation, including bank statements, LLC docs, title seasoning, voided checks, sometimes tax returns. Investors could be forgiven for aspiring to a less-invasive process.

3 Major Hard Money Alternatives

Now that we understand why a hard money alternative might be desirable, let’s look at three core alternatives to hard money loans:

‍

• DSCR Loans
• Business Working Capital Loans
• Private Money Loans

DSCR Loans

What Is a DSCR Loan?

Like a hard money loan, a DSCR loan is a type of investment real estate mortgage. Like a hard money loan, it depends not on the borrower’s employment history and personal income, but rather on the economic viability of the investment.

‍

What makes a DSCR loan different is that it is a long-term loan — often 30 years, just like with a conventional mortgage. 40-year terms and ARMs are available too. In many ways they resemble a conventional mortgage, but for investors.

‍

Instead of relying on the borrower’s personal income, a DSCR loan (as its name implies) relies on the calculated DSCR of the property — the debt-service coverage ratio. 

‍

The math at the core is simple — take the annual net operating income (NOI) of the property and divide it by the annual debt service, and you end up with a number either less than, equal to, or greater than 1. 

‍

If the number is greater than 1, the property can reasonably be expected to generate more than enough rental income to cover the debt service with cash flow to spare. If the number is less than one, the property probably can’t produce enough income to cover the debt service after expenses.

‍

The big x-factor is the lender’s estimate of the potential NOI. Lenders use factors like:

‍

• The appraiser’s estimate of market rent found on Form 1007 of the appraisal.
• Leases in place and financial records (if the property is already rented out).
• Data available from property aggregators like AirDNA (for short-term rentals).
• Industry assumptions about expenses and vacancy as a percentage of the gross income.

‍

Typical DSCR Loan Terms

• Interest: Usually 1-2% higher than conventional mortgages — a big advantage of DSCR vs hard money loans.

• Down Payment: 20-25% for acquisitions; 25-30% for refinance.

• Closing Costs: Typically 3-6% of the loan amount.

• LTV/LTC: 75-80% for acquisitions; 75-80% for refinance.

• Loan Term: 30-year fixed, 40-year interest only, ARM.

• Approval Time: 5-21 days.

‍

Ideal Use Cases

‍

• BRRRR. A DSCR loan is potentially the ideal vehicle for BRRRR (buy-rehab-rent-refinance-repeat) financing because the ultimate intention is to rent out the property, making the DSCR a relevant metric. DSCR loans also typically have shorter refinancing “seasoning” periods, requiring the borrower to wait only 1-3 months before refinancing (compared to 6-12 months for conventional loans).

‍

• Short-Term Rentals. Certain DSCR lenders distinguish themselves from conventional lenders in their willingness to fairly evaluate the income potential of a property when used as an Airbnb or short-term rental. Even if the property hasn’t been used as an Airbnb in the past, some DSCR lenders will use market data sources to come up with a fair estimate.

‍

DSCR Qualification Requirements

‍

• DSCR Requirement. Most DSCR lenders look for an estimated DSCR of at least 1 (meaning they estimate the NOI will be sufficient to cover the mortgage payment, property taxes, and insurance). Many DSCR lenders require a higher DSCR, like 1.1 or 1.2. Certain DSCR lenders will consider DSCRs under 1 if there are special circumstances.

‍

• Credit Score Requirements. DSCR loans have similar credit-score requirements of the borrower to conventional loans — they start considering you at a credit score of 620, with credit scores over 700 activating the lowest interest rates and other favorable terms.

‍

• Appraisal. DSCR lenders will order an appraisal and must be satisfied with the results, though some lenders won’t slavishly adhere to the Form 1007 market rent estimate, especially if the borrower is proposing an Airbnb or short-term rental strategy. 

‍

• Cash Reserves Requirement. DSCR lenders will usually require that the borrower have enough cash reserves to cover several months’ worth of debt service — at least three months, sometimes as many as twelve months.

‍

DSCR Strengths & Limitations

Strengths:

• Fast funding
• Reasonable interest rates and closing costs.
• Approval is based on property income potential.
• No need to verify personal income or employment history.
• Flexible underwriting.
• No cap on the number of loans you can have, empowering investors to scale.
• Fast refinancing, usually 1-3 months.
• Will fund into an LLC.

Limitations:

• Only available for 1-4 unit buildings — sometimes 5-8 units.
• Will not lend rehab budget.
• Higher down payment requirements.
• May include prepayment penalties for early payoff.

‍

Business Working Capital Loans

‍

‍

What Is a Business Working Capital Loan?

‍

A business working capital loan is a kind of loan that can be extended to just about any business (including a real estate investment company) that needs working capital to cover operating expenses or major projects. They can be lump-sum loans or lines of credit, and are often unsecured — meaning there is no lien against the property, a big bonus of working capital vs hard money and other mortgage loans. If you default on the loan, the lender can’t automatically foreclose on the property.

‍

Working capital loans get approved based on cash flow, revenue, and longevity in business. Loan balances range from $10,000 to $500,000 or more. Lump-sum working capital loans usually have longer terms than hard money loans — perhaps 5-7 years — with monthly payments and reasonable interest rates. 

‍

Typical Business Working Capital Loan Terms

‍

• Interest: Long-term lump-sum working capital business loans can carry very reasonable interest rates, as low as 7-10%. Working-capital lines of credit and shorter-term loans can have higher interest rates, sometimes in the “credit card” range of 20%+.

• Down Payment: No down payment required for many lump-sum unsecured working capital loans or lines of credit. Secured loans may require cash collateral.

• Closing Costs: Origination fees range from 0-5% depending on the risk profile, plus various cursory ACH and filing fees. A broker fee ranging from 2-10% may apply, but not always.

• LTV: Non-applicable — the credit extended is based on cash flow, longevity, and creditworthiness of the business, not on the value of the property. Loan balances can range from $10,000 to $500,000 or even beyond.

• Loan Term: Longer-term working capital loans range in term from 5 to 7 years. Working capital lines of credit are usually reviewed annually, but pending approval may be kept open indefinitely. 

• Approval Time: Short-term working capital loans can be approved in as little as 24-72 hours. Longer-term loans usually require several days or weeks to approve.

‍

Ideal Use Cases

‍

• Rehab Costs. Fix-and-flippers and BRRRR investors can use working capital loans in concert with other loans — like DSCR loans, which don’t finance the rehab itself, only the acquisition — to cover rehab costs. The funds can be used to get better rates from contractors by paying early, without having to wait for the draw schedule or inspections required by a hard money loan.

• Holding Costs. Working capital loans can act as a cash cushion to cover operating expenses of the investment during lean cash flow periods — utilities, repairs, insurance, property taxes, even mortgage payments.

‍

• Emergency Expenses. If a major expense arises — damage, eviction, lawsuit, etc. — a working capital loan can provide the quick cash needed to keep the deal afloat. Working capital lines of credit are particularly good for this purpose because you only draw on them (and pay interest) as needed.

Business Working Capital Qualification Requirements

‍

• Time-In-Business Requirements: Most working capital lenders do not want to extend unsecured credit to brand-new businesses. Usually the business entity will need to have been formed at least 2 years ago, with financial records extending back at least those two years. Higher balances may require more time in business, but some working capital lenders will consider entities that have been in business for 12 months or even less.

‍

• Annual Revenue: Working capital lenders usually want to see at least $150,000-$250,000 in annual revenue, with more revenue for larger loan balances. They prefer not to see severe revenue fluctuations.

‍

• Personal Credit Score of Borrower: Borrowers must usually have a credit score of at least 660 to qualify for an unsecured business working capital loan, though some lenders are more flexible. 

‍

• Business Credit Score: If available, the lender will check the company’s credit rating with the major business credit reporting bureaus (PAYDEX, SBSS, Experian Biz). They will also research payment history with vendors, outstanding liens, judgments, lawsuits, and UCC filings. 

‍

• Profitability: The lender may do its own version of a DSCR calculation — measuring the annual revenue against expenses to see how much is left over for service on the debt you are requesting. However, they are not always as strict about this metric as DSCR lenders. 

‍

• Bank Health: At the same time as they check bank statements to verify revenue, lenders will look for overdrafts, negative-balance bank days, and consistency of the average daily balance.

‍

• Existing Debt: The lender will look at the company’s current monthly debt obligation, with particular scrutiny on short-term high-interest debt and evidence of “debt-stacking.”

‍

• Use Of Funds: The lender will require a business plan that explains the exact use to which you intend to put the loan proceeds. 

Business Working Capital Strengths & Limitations

Strengths

• Often unsecured debt.
• Can fund quickly.
• Funds can be put to any use you want (with one big caveat for real estate investors — see below in “weaknesses”).
• Reasonable interest rates on long-term debt.

Limitations

• Can not be used as down payment. Nearly every mortgage lender forbids using borrowed funds for down payments. Attempting to do so could open the borrower up to legal liability.
• “Time-in-business” requirement rules out newer businesses.
• Shorter repayment periods mean higher monthly payments.

‍

The Private Money Alternative

‍

What Is a Private Money Loan?

‍

Private money loans are the most flexible loans of all. Instead of borrowing from an institution, in this case you would borrow the money from an individual, family, or family office. Because lending is an allowable use of funds in an IRA or 401(k), many individuals with self-directed IRAs or 401(k)s choose to use those funds to make private loans. They can even enlist an attorney to create and file a legal lien on the property, securing the debt with the real estate just like with a mortgage from a bank or hard money lender.

‍

As you might imagine, private money loans depend on relationships. The lender usually has to know, like, and trust you. They may lend an investor the money they need when no institution will — but only if the relationship is strong. Private money loans often come from family members or close associates — situations where there is a major personal, if not financial or legal, cost for the borrower defaulting.

‍

Because they often don’t have the underwriting or resale ecosystem of professional or institutional lenders, these loans tend to have higher risk profiles and the lenders often require higher interest rates. The upside is that the sky is the limit on the terms. The private lender can make the loan as high-interest or low-interest they want, the term as long or short, with whatever repayment terms and as many or as little closing costs as they like, as long as both parties agree to the terms.

‍

Typical Private Money Loan Terms

‍

• Interest: There are no rules, but the typical APR range for private loans is 8-12%, though with close relationships the rate could be much lower.

• Down Payment: 10-20% is standard, but again with close relationships the down payment could be anything the lender will agree to, even 0%.

• Closing Costs: The lender may charge the borrower 1-2 points and may pass off $500-$1000 in attorney fees to the borrower.

• LTV/LTC: Once again, the lender can extend as much LTV or LTC as the parties agree to. Standard terms are 65-80% of the purchase price, 60-70% of the ARV, even up to 90% LTC for favored borrowers.  

• Loan Term: Private lenders generally don’t want to hold their loans for decades. The amortization schedule may keep the payments low, but many private loans have terms as little as 12 months, or 2-5 years or longer for favored borrowers. As always, it’s all based on what the parties agree to. 

• Approval Time: Here’s where private loans really shine — for borrowers with whom they have a strong relationship, all it takes is the time for an attorney to draw up the paperwork and the funds to wire, sometimes as little as 2-10 days.

Ideal Use Cases

‍

• Small Deals. Private money lenders often don’t have pockets as deep as banks, so they tend to be better for light rehabs and duplexes.

• Distressed Sellers. Many distressed deals are up against a foreclosure clock. The speed at which a private money lender can move may be essential.

• Joint Ventures. A private money loan may be especially attractive when the lender is an equity partner on the deal. The lender can therefore be more hands-on and stands to benefit above and beyond the interest on the loan.

‍

Private Money Loan Qualification Requirements

‍

Private money lenders can set their own qualifications. If the relationship with the borrower is strong enough, they may not require any docs, no credit pull, etc. However, smart private money lenders do their due diligence and will probably do some kind of background check on borrowers that are not part of their immediate family.

Strengths and Weaknesses of a Private Money Loan 

Strengths

• Fast funding.
• Possibility of speedy qualification with few or no docs.
• Flexible terms — anything the parties agree to, including interest-only payments, delayed payments, etc.
• Often few closing costs.

‍

Weaknesses

• Often higher interest rates and cost of borrowing.
• Shorter terms.
• Possibility of relationship damage.

‍

Bottom Line

‍

Real estate investors who think their only option is a high-cost hard money loan actually have more options than they may realize. Hard money alternatives include: 

‍

• DSCR Loans — similar to conventional loans, but based on the income potential of the property.
• Business Working Capital Loans — based on revenue and time in business, often unsecured.
• If all else fails, there’s the private money alternative.

‍

Each of these options have their strengths and weaknesses. Not every option is right for every investor. But when faced with the limitations of hard money loans, savvy investors owe it to themselves to explore all their options.

Munoz Ghezlan Capital has helped dozens of investors discover hard money alternatives they never even knew they had, connecting them with lenders that can offer much better terms. If you want to break out of the hard money box and discover a world of more attractive financing options, schedule a complimentary strategy call with a Munoz Ghezlan Capital expert today. We routinely show investors that they qualify for much more funding — at much better terms — than they thought possible.