DSCR Loan Clarification Post

[Sanat Bhandari]

I've seen a ton of interest in the DSCR loans from investors and just wanted to clarify some of the minor details of an actual DSCR loan:

- The rental income used to calculate DSCR is based on the lower of market rent value on the 1007 or the rents at which the subject property is rented out. 

So if you rented your property for $1,500/mo and 1007 says the market rent value if $1,300/month, we'll be limiting your leverage based on the $1,300/month number and not the former. 

- DSCR = NOI/DS (NOI = Net Operating Income and DS = Debt Service) is correct and used for MFH and commercial property DSCR evaluations

However, on 1-4 unit properties from a lending perspective, DSCR = (Lower of gross Income determined by 1007 or lease agreement)/PITI (add flood insurance to the denominator if the property is in a flood zone, HOA if there is one)

- Your credit score matters a lot in determining the terms of the loan . The difference in terms between a 680 and a 740 is fairly substantial (a higher differential in pricing than if the loan was conventional/FHA/VA/USDA type)

- There's customizable options for everything, including rate locks, prepays, front-end/back-end broker compensation, I/O options (and a range of I/O options) etc

- Generally speaking, we're looking at seeing immediate access to 6 month liquid reserves (not necessarily escrowed) so that the buyer can cover the property's debt after closing were it not to be leased 

A real life example: a client of mine thought the DSCR for his property is 1.2 for a cash-out refinance based on

DSCR = $1000 (current leased value)/$750 (PITI) = 1.2 ------- (1) 

Upon closer inspection, found out that the property is in a flood zone which adds $100/month to the expenses. To add to the mix, there was an HOA of $50/month and the appraisal came in at $950/month for market rent value. By the time the loan got to closing, the DSCR evaluated was

DSCR = $950 (lower of the 1007 value/leased value)/($750+$100+$50) = 1.055 --------- (2) 

The difference in rate pricing between (1) and (2) was a cool 75 bps or 0.75% interest rate which in the current climate can completely kill cash flows. 

When I started out as an investor, I made this mistake. I see plenty of investors making this mistake and failing to realize that these nuances and wanted to make sure others learn from my experience

[Nicholas L.]

@Sanat Bhandari

lenders I've worked with don't look at the lower of actual or market, if it's rented they just the actual

[Sanat Bhandari]

@Nicholas L. I agree, there's wholesale lenders out there that look at actual rents vs lower one but I believe it's better to follow this rule while underwriting deals with anything extra over 1007 rents as cherry on the top

[Nick Belsky]

@Sanat Bhandari

I find this as mostly true, however, it really depends on the lender. Wholesale DSCR lenders are trash. Private lenders are way better and more flexible with terms. I don't think any of the items you pointed out would ALWAYS be true, but in many cases, yes. One thing with DSCR that holds true anywhere is that they are for non-owner occupied properties only. It drives me nuts when people get on BP and state that they have owner occupied DSCR loan options.

Cheers!

[Sanat Bhandari]

Quote from @Nick Belsky:

@Sanat Bhandari

I find this as mostly true, however, it really depends on the lender. Wholesale DSCR lenders are trash. Private lenders are way better and more flexible with terms. I don't think any of the items you pointed out would ALWAYS be true, but in many cases, yes. One thing with DSCR that holds true anywhere is that they are for non-owner occupied properties only. It drives me nuts when people get on BP and state that they have owner occupied DSCR loan options.

Cheers!

Great points right there, absolutely correct! Wholesale DSCR lenders are a pain to work with more often than not. Through trial-and-error, I've found some decent ones but most lenders are terrible.

100% agree with you right there, if one has access to private capital, that's the way to go. The biggest utility that DSCR lenders provide is the ability to fund deals with DSCR <1 on a 30-year am. Because of this utility, most of the loans I do are the ones that banks/most private lenders don't want to touch with a 10 foot pole. I believe it is this exact loan scenario that is keeping wholesale DSCR lenders in business

This is also the reason why I always caution investors to be as conservative with their underwriting as possible. When s*** hits the ceiling (like the current market we're in), one is almost pigeonholed into financing with terrible terms

[Stephanie P.]

The key to working with wholesale DSCR lenders is to know what they do, what they need in the loan to do what they do AND know what they don't do or bend on. What many brokers do that makes a rough situation worse is they send a wholesale lender a loan that needs exceptions and expect them to do it because you have a "relationship" with them. The relationship may be with the broker and the account executive, but that wholesale lender has to sell that loan in a pool and if it has exceptions that they can't justify, then they're on the hook for the loan or they'll sell it at a discount.

Most wholesale lenders are really good at what they do and really bad at what they don't do.

One girl's opinion

Stephanie 

[Jonathan Taylor]

@Sanat Bhandari great breakdown and what I have seen is lenders making exceptions on market rents since Debt coverage is one of the main reasons loans aren't working at higher LTV.

[Sanat Bhandari]

@Stephanie P. Great points right there, thank you. I agree with you since I've learned this lesson the hard way

@Jonathan Taylor Lending guidelines are the reason that I would limit my own BRRRR leverage to 65 at the most. You're absolutely correct, most of these loans I'm doing right now are limited because of DSCR ratio. Rising interest rates have led us to the point where I'm seeing scenarios like 55 LTV at a 1.1 ratio lol

[Jonathan Taylor]

@Sanat Bhandari the smaller purchases (sub 500k) are still working 65-70. The larger properties (1m+/-) is where 55 -60 LTV are debt covering. 1.1 is tight. Most of my lenders are 1.2+ since we aren't out of the woods yet in terms of rate increases AND rent stagnation/decline.

[Sanat Bhandari]

Quote from @Jonathan Taylor:

@Sanat Bhandari the smaller purchases (sub 500k) are still working 65-70. The larger properties (1m+/-) is where 55 -60 LTV are debt covering. 1.1 is tight. Most of my lenders are 1.2+ since we aren't out of the woods yet in terms of rate increases AND rent stagnation/decline.

Makes sense, I quoted a client for a commercial property and most places are limiting leverage on commercial assets to 60 LTV (I know there's plenty of others that will provide more but considering the market, 60 isn't a bad place to be)

On a related note, low-ratio DSCR (<1) loans are fairly popular right now despite their relatively absurd rates (9.xx with >1 origination points)