DSCR refinance loan against a property leased on a lease option

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DSCR refinance loan against a property leased on a lease option

Brian Kempler
Member since 2021 · 87 posts · 14 votes

Hi, if I lease my house to a tenant, and the tenant has an option to purchase, will DSCR lenders look unfavorably upon the tenant's purchase option? Are DSCR refinance loans ever approved in this case?

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Nick BelskyBusiness Member
Lender · Orlando, FL · Member since 2021 · 1k+ posts · 704 votes
2y

@Brian Kempler

I haven't had a lender reject a lease due to this specifically, but the tenant purchase option would be an exit option. If your DSCR has a prepayment penalty, you'd need to make sure you account for that penalty in the sales price to offset it. From the tenant's pov, I don't see why a conventional lender would have issues with a tenant buying the property as a primary that they've been living in.

Cheers!

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  • Ko KashiwagiPro Member
    Lender · Los Angeles, CA · Member since 2022 · 967 posts · 445 votes
    2y

    Hi Brian,

    In general, most DSCR lenders will not allows lease options in the lease agreement. Also, most DSCR programs have pre-payment penalty to get the best rates, so you would take a hit on points if you sell within a few years.

    310-848-9776
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  • Nick BelskyBusiness Member
    Lender · Orlando, FL · Member since 2021 · 1k+ posts · 704 votes
    2y

    @Brian Kempler

    I haven't had a lender reject a lease due to this specifically, but the tenant purchase option would be an exit option. If your DSCR has a prepayment penalty, you'd need to make sure you account for that penalty in the sales price to offset it. From the tenant's pov, I don't see why a conventional lender would have issues with a tenant buying the property as a primary that they've been living in.

    Cheers!

    [email protected]
    Belsky Mortgage, LLC521 Reviews
    WebsiteView Page
    1Reply
  • Patrick Culleton
    Investor · GA · Member since 2018 · 20 posts · 11 votes
    2y
    Quote from @Brian Kempler:

    Hi, if I lease my house to a tenant, and the tenant has an option to purchase, will DSCR lenders look unfavorably upon the tenant's purchase option? Are DSCR refinance loans ever approved in this case?


    I think your biggest concern would be the pre-payment penalty that comes with most DSCR loans. If the tenant purchases prior to the PPP term, you may be in a tough spot. However I wouldn't expect this to stop you from getting approved, but it may mean you should consider looking at alternative options or structure the deal in a way where you won't be caught with a net loss due to the PPP.

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  • Erik EstradaBusiness Member
    Lender · Member since 2022 · 6k+ posts · 1k+ votes
    2y
    Quote from @Brian Kempler:

    Hi, if I lease my house to a tenant, and the tenant has an option to purchase, will DSCR lenders look unfavorably upon the tenant's purchase option? Are DSCR refinance loans ever approved in this case?


     Hey Brian, 

    This would depend on your DSCR loan structure. If there is a PPP the lender will hit you for the year you land on the PPP term. In terms of it raising any questions in UW, not at all. They may ask for a basic LOE but that's if they are really nit picky.

    [email protected]818-269-7983
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  • Nghi Le
    Investor / Lender · Seattle, WA · Member since 2014 · 1k+ posts · 730 votes
    2y

    Most DSCR lenders will disqualify lease options. Find the ones that can do it, and it also helps if you have separate contracts for the lease and the option. If you structure your lease option correctly, it'll actually benefit your DSCR loan.

    I have a lease-option tenant buyer that's currently in a 10-year lease option with me. Knowing that I had a 3-year prepayment penalty, I structured the lease option so that if the option is executed within 3 years, then the tenant buyer pays that fee for me. He was fine with it because I gave him a 10-year term. If you are only doing a 1-2 year lease option, then I'd recommend you just buy down the prepayment penalty to 1-year and just eat it if the borrower executes early. These days, I'm only doing 1-yr prepay DSCR loans anyway because I expect rates to go down to where I'd want to refinance within 2 years.

    The other thing I did was beef up the monthly rent so that I could better qualify for the DSCR loan (but you need to use a lender that uses actual rents instead of market rents). Market rent was about $3,300 at the time, but we agreed to a $5,000/month rent that includes $1,000 rent credit (which was stated on the option contract, not the lease contract). This helped me get the max LTV on a high balance loan. It's also a good strategy for the current market since things are hard to cashflow these days with the high interest rates.

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  • Taylor Dyer
    Member since 2022 · 1 post · 0 votes
    1y

    @Nghi Le I would love to hear more and connect! How can we make that happen? 

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  • Stacy RaskinBusiness Member
    Lender · Member since 2022 · 1k+ posts · 525 votes
    1y

    There are some lenders that will do a DSCR loan with an option to purchase as long as they can't exercise the option for longer than one year. DSCR guidelines vary by lender and working with a mortgage broker or lender that specializes in these mortgages can help get better terms such as a DSCR 1 ratio vs a DSCR 1.2 ratio. You will want to make sure to match the prepayment penalty with the purchase option if you don't want to have to pay that.

    More info on DSCR loans:

    DSCR loans won't use your income to underwrite the loan.

    DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth.

    Here's a bit more in detail about how rates are calculated for DSCR loans:

    1. Credit score- the higher the best. 760-780+ generally gets best pricing for investment property loans with most lenders. From there every 20 point increment affect pricing differently. So for example, a 761 credit score will be in the 760-779 credit category, then going down to 740-759 and so on.


    2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.

    3. Prepayment penalties- usually 1-5 year terms. The shorter the prepayment term has an impact on increasing the rate.

    4. Are you cash flowing the property? More on how that is calculated below. Is your DSCR ratio greater than 1-meaning are you cash flowing (according to the lender's criteria of mortgage, property taxes and insurance (and HOA) if applicable). Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit. This criteria is for 1-4 and 5-8 unit programs.

    I've included an example below to help illustrate this.

    So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.

    See example below:

    DSCR < 1

    Principal + Interest = $1,700

    Taxes = $350, Insurance = $100, Association Dues = $50

    Total PITIA = $2200

    Rent = $2000

    DSCR = Rent/PITIA = 2000/2200 = 0.91

    Since the DSCR is 0.91, we know the expenses are greater than the income of the property.

    DSCR >1

    Principal + Interest = $1,500

    Taxes = $250, Insurance = $100, Association Dues = $25

    Total PITIA = $1875 Rent = $2300

    DSCR = Rent/PITIA = 2300/1875 = 1.23

    If a purchase, you also generally need reserves / savings to show you have 3-6 month payments of PITIA (principal / interest (mortgage payment), property taxes and insurance and HOA (if applicable). If a cash out refinance, many lenders will allow the cash out to satisfy the reserves requirement.

    DSCR lenders generally let you vest either individually or as an LLC. It's a great way to increase your net worth and these loans can also be used to pull cash out of a property as it appreciates allowing you to reinvest money into new deals.

    Happy to discuss further. 

    [email protected]818-770-0340
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  • Nghi Le
    Investor / Lender · Seattle, WA · Member since 2014 · 1k+ posts · 730 votes
    1y
    Quote from @Taylor Dyer:

    @Nghi Le I would love to hear more and connect! How can we make that happen? 


    Hi Taylor,

    I'm not on BP very often anymore, so please feel free to email or call me.  BP doesn't let us post emails or phone numbers on forums, but I just sent you a connection request so we can exchange contact info.

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