Conventional to DSCR Loan: Am I Crazy?

[Mark S.]

Goal: Restructure existing debt, keep payment around the same, pull cash out for reinvestment purposes (thereby increasing LTV).

How: DSCR loan / portfolio loan. Open to other ideas here, too.

Current Situation: I have 5 SFRs in Memphis, TN, each on 30-yr fixed rate loans.  Weighted average interest rate is right at 5.00%.  Purchased these turnkey properties initially with 20% down (and got these loans) in personal name, had title company quitclaim to SMLLC.  Let's save the due-on-sale for another discussion.  As we all know, we're experiencing quite a bit of price appreciation (even in markets like Memphis, which aren't historically known for it).  I'm considering restructuring the debt on these rentals and pulling some cash out.  

My local credit union that I have a relationship with (and do my business banking with) does not lend on property outside of KY. I've been in contact with a couple of commercial brokers from BP and they have some interesting products, including 30-year fixed loans with similar/lower interest rates to what I have (depending on LTV, etc.). I could potentially kill all the conventional 30-year fixed Fannie/Freddie backed loans and wrap it all into one DSCR loan or portfolio loan made to my SMLLC. Seems like a no brainer, but I'm finding the fees/costs for these loans seem quite high (in the five figure range - like $10K-$15K).

Depending on the LTV, I could probably get anywhere from $50K to $100K out (wide range, I know). Total loan size would be in the $350K-$450K range. With one lender, the fees don't change (need to check with the other one - waiting on a rate sheet from them). My total PITI payment would be +/- a few hundred per month depending on which route I go. These funds would likely be reinvested into a self-storage/mobile home park fund.

As a side note, I am also in the process of getting a HELOC on my primary where I could likely get about $65K-$70K (promotion w $0 closing costs, variable rate right now at 3.50%). This seems like the cheapest cost of capital by far, however, it doesn't really address the built up equity issue with the rentals (my SFR portfolio is sitting at about 55% LTV right now, and I'd like to see that higher).

Bottom Line: I have excellent credit, strong income, and am very "bankable."  From what I told, many people that get these types of loans are either "Fannie/Freddie'd out" or they don't have much (if any) documentable income (and therefore the fees are quite a bit higher).  I'm trying to figure out whether or not it makes sense for me to move forward with one of these products.  Am I crazy to do it...or am I crazy NOT to do it...?  Just feels a bit silly to pay $10-$15K to "get" $50K-$100K when I don't "need" it necessarily.  I've always heard your 30-year fixed Fannie/Freddie loans are like gold, but these DSCR loans seem competitive from an interest rate/term standpoint.

Downsides: The only potential downsides that I'm aware of besides the fees are that if I ever wanted to sell just 1 or 2 properties, when those sales close, the proceeds go towards the outstanding principal balance on the loan (I don't get the cash).  There's also a prepayment penalty for the first few years (which doesn't really bother me as these are intended for long-term buy and holds).  I'm sure I might be missing something here, not sure...?

Positives: On a positive note, doing this would free up 5 conventional loan slots for future acquisitions. My interest rate would be lower (likely around 4.375% to upper 4s depending on LTV). I'd have more cash NOW to reinvest. I would increase the LTV on the portfolio and keep that money working. Once completed, everything would be in the name of the SMLLC (properties, loan, etc.).

Sidenote: I did talk to my residential lender about a possible refinance.  He quoted $3,300 to refinance ONE property, 0.50% lower rate, cash out.  So, on a relative basis, maybe $10-15K isn't so bad considering if I did them all individually, I'd be paying around $16.5K.  

What do you guys think?  What am I not considering?  What other info might you need to share your thoughts?  Thanks in advance.

[Caroline Gerardo]

Cash out non owner loans are expensive right now. The cash out costs 30%, oh no, ugh, gulp. Cross collateralizing is a mistake. You are handcuffed to the lender and cannot sell off one property. My guess they add in a prepay last second and they got you if you want to release one property. How will they handle the fire/homeowner insurance??? If you did 5 conventional refinances each will cost $3000 base fees and by the time you add non owner and cash out it's going to be similar in cost to the DSCR. HELOC owner occupied is cheapest but don't count on the line remaining open if the market goes down, bank closes it. Fees for HELOC are $60 annual only BUT ~ HOWEVER ~ amortized over 15 and max rate, oh no I hate to point out: 18%. If you can afford the fully amortized payment on a HELOC of $50000 at $805 a month then take the HELOC, draw the cash out and start paying $805. Talk to your CPA about juggling the interest write offs- the cash out HELOC doesn't count as primary residence interest paid - as is put into the business pool. Keep perfect accounting records. And I didn't chide you about changing the deed, if they are Freddie loans apply with your servicer for the exception. Since you are only a blue head and no last name ... what are you doing with the insurance? If you have a claim will your agent give you a check? If you change the insurance the lender will know.

[Stephanie P.]

@Mark S.

Your analysis of the deal is correct in a lot of ways.  

• The loans are tied together and are near impossible to break out if you ever wanted to sell one.  
• There is a prepay and I'm not aware of anyone that is sneaky about it; it's 5 years on the portfolio product.
• You have to get appraisals on all of the properties
• There's a minimum 100K property value for each loan in the portfolio depending on the lender you use.

Those are the bad parts, but having a no income verification loan product (even if you can verify income, it can be a pain) where rates are better than Fannie/Freddie is a huge plus and with cash out to boot, it's not a bad deal, particularly considering the closing costs you're saving by doing 5.

Costs should be around 2 points plus some lender fees.  Unfortunately there's no getting around points unless you want to increase the rate to accommodate yield spread.  Doesn't matter to most lenders I know.  It's always borrower's preference.

The key with these is to get some proposals and weigh them (like you are).  If they work, then run with it.  If not, at least you know what's out there.

Best of luck

Stephanie

[Mark S.]

@Caroline Gerardo, I'm trying to follow along with your post but am getting lost at certain points.  Let me take it one portion at a time.

Yes, cash out non-owner loans seem expensive right now in upfront fees/costs.  Long-term interest rates seem okay.  

You are correct on the selling of one property.  I'm not planning to do that, but good point.  The lenders I've spoken with so far are very upfront about prepay penalties (generally 3-5 years).

Great question about insurance.  I would imagine I would simply need to provide proof of insurance on each property and could likely keep the same insurance in place that I have now.  Why would that change?

I'm okay if the HELOC gets closed. To my knowledge, there is no demand feature. I would only use it for investment purposes, so if the money is already out, it's out. If they shut the line down before it's tapped, I can still eat tomorrow.

The HELOC I plan to use is up to 10 years interest only followed by 20 years principal and interest. Not sure where you're getting 15 years. Max rate is 15%. They can only hike it up to 2% per year. There is a fixed rate lock feature that can be used up to 3x during life of HELOC that locks in at 50 bps higher than current variable rate. Variable rate is PRIME minus 0.51% with a 3.50% floor. If rates start to tick up and I have a large outstanding balance, I can simply lock the line at a fixed rate 0.50% higher than the then current variable rate - no big deal. No annual fees. No closing costs (promo). I agree with what you said about interest tracing and recordkeeping - already doing that.

Am I understanding correctly that you are saying to poke the servicer and ask them for an exception on my existing loans for the quitclaim to LLC that already happened? Why would I do that? Chances are I'm unnecessarily raising a red flag and they're likely to say no anyway. And if I go the DSCR route, this becomes a moot point.

The LLC is listed as an additional insured. Both my "blue head" personal name and LLC name are listed on the policy. If there's a claim, they will pay the claim. Again, not an issue if I go the DSCR route.

[Matt Devincenzo]

It looks like DSCR may be better for you currently. I've noticed with clients in my day job (land use/Civil development), once they reach the 'commercial' space they're actually better off...rates are often not as bad as you might think...sometimes even better. Qualifications are easier, your underwriter advocates for your approval, not just pushes paper...

One clarification on your points above. Doing DSCR or not will not free up conventional loan spots...the criteria is 'more than 10 financed properties' so no matter who lends on it it will still use up the same number of loans if you wanted to pursue conventional later. 

[Mark S.]

Good point,@Matt Devincenzo. I thought (and surprisingly was told by at least one DSCR lender) otherwise.

[Caroline Gerardo]

If your loans are Freddie - they MAY grant a ride allowing the LLC if is single person. If Fannie, mum's the word, they will never allow it. Lookup loan if Fannie here: https://www.knowyouroptions.co...   If Freddie here: https://loanlookup.freddiemac.com   You would only ask for the exception if you are leaving the status quo.

All HELOC's are subject to market conditions. When the crash happened in 2008 they all got closed, no matter what equity or perfect person you are. HELOCs are rarely a 30 year loan, almost all are shorter term without any annual cap. Read your note carefully. What I was saying is draw the money, then if they close it, who cares.

Whoever is doing the debt service ratio loan is probably brokering to a source and the source may be selling to Goldman Sacs. If you DM me who it is I could advise on deeper level. This means the person you are dealing with may, or maybe not, knows what conditions will arise at final Underwriting (depends on how many they do at that shop). The Underwriter may want one insurance commercial policy that blankets everything

Insurance notes LLC name - lender will find out some day, maybe when rates go up and the servicer feels greedy. Insurance policy is checked twice annually by servicer. Small loan probably gives you better chance of not being noticed by servicer.

Hope this helps

Happy Trails

[Kerry Baird]

I've been doing the DSCR mortgages, since reserve requirements became onerous, at non owner occupied mortgages 5, 6, 7, 8, 9 and 10.

[Frank Glemstone]

Originally posted by @Caroline Gerardo:

If your loans are Freddie - they MAY grant a ride allowing the LLC if is single person. If Fannie, mum's the word, they will never allow it. Lookup loan if Fannie here: https://www.knowyouroptions.co...   If Freddie here: https://moneyzap.com/blog/check-cashing-near-me/ You would only ask for the exception if you are leaving the status quo.

All HELOC's are subject to market conditions. When the crash happened in 2008 they all got closed, no matter what equity or perfect person you are. HELOCs are rarely a 30 year loan, almost all are shorter term without any annual cap. Read your note carefully. What I was saying is draw the money, then if they close it, who cares.

Whoever is doing the debt service ratio loan is probably brokering to a source and the source may be selling to Goldman Sacs. If you DM me who it is I could advise on deeper level. This means the person you are dealing with may, or maybe not, knows what conditions will arise at final Underwriting (depends on how many they do at that shop). The Underwriter may want one insurance commercial policy that blankets everything

Insurance notes LLC name - lender will find out some day, maybe when rates go up and the servicer feels greedy. Insurance policy is checked twice annually by servicer. Small loan probably gives you better chance of not being noticed by servicer.

Hope this helps

Happy Trails

 I think nowadays even a small loan could get you noticed. All comes to your credit score, people with a high score could get off anything, even get their loan refinanced, or can get low rates but people with low scores could only get bankrupt. 

[Kerry Baird]

@Mark S. Did you end up going with the DSCR loans? I have been getting updates to the few lenders I subscribe to, that rates are falling. I don't have mine in a blanket, but rather do individual loans.

My houses are in an LLC structure, and I have some short term rentals, some long term rentals. A few lenders will do the STR side.

[Mark S.]

@Kerry Baird, yes, I did. 3.75% fixed for 30-years at 70% LTV. Pulled 100%+ of my cash out.

[Kerry Baird]

Way to go, 

@Mark S. ! That’s how it is done! 

[Guilliana Paz]

Quote from @Kerry Baird:

@Mark S. Did you end up going with the DSCR loans? I have been getting updates to the few lenders I subscribe to, that rates are falling. I don't have mine in a blanket, but rather do individual loans.

My houses are in an LLC structure, and I have some short term rentals, some long term rentals. A few lenders will do the STR side.

Hi I hope you see this. How do you get an LLC structure? How do I apply for that?

[Mark S.]

Correction: 75% LTV

[Mark S.]

Quote from @Mark S.:

@Kerry Baird, yes, I did. 3.75% fixed for 30-years at 70% LTV. Pulled 100%+ of my cash out.

Correction: 75% LTV

[Mark S.]

Quote from @Guilliana Paz:

Quote from @Kerry Baird:

@Mark S. Did you end up going with the DSCR loans? I have been getting updates to the few lenders I subscribe to, that rates are falling. I don't have mine in a blanket, but rather do individual loans.

My houses are in an LLC structure, and I have some short term rentals, some long term rentals. A few lenders will do the STR side.

Hi I hope you see this. How do you get an LLC structure? How do I apply for that?

Not sure what you mean. I purchased each one individually in my own name and then transferred the deed (via title company) to my single member LLC. Once I had them all in my LLC and more favorable financing was available, I pulled the trigger. Still 30-year fixed at 3.75%, got all my cash out, payment went up a couple hundred bucks a month, but then put that money into REI syndications that produce even more monthly cash flow.

[Chris Davidson]

@Mark S. great post to follow. What was the time frame on initial purchase to refi. I know this was during a huge boom era, but feel like it shows REI work they just take time and require thoughtful action.

Keep up the good work!

[Kerry Baird]

@Guilliana Paz, I paid a lawyer to set up an LLC for me. I bought the houses with the LLC as the owner and using @Timothy Hero as the broker.

[Mark S.]

Quote from @Chris Davidson:

@Mark S. great post to follow. What was the time frame on initial purchase to refi. I know this was during a huge boom era, but feel like it shows REI work they just take time and require thoughtful action.

Keep up the good work!

Hey Chris, 
Purchased first one in 11/2017 and fifth one in 1/2020.  Did DSCR cash out refi in 10/2021.  These were all turnkey.  A BRRRR without any effort on my end - I just got lucky.  

We have a couple others with the original 30 year fixed loans on them.  One is at 3.625% and the most recent (7/2022) at 6.375%.  Boy, how things can change quickly.  

[Chris Davidson]

Quote from @Mark S.:

Quote from @Chris Davidson:

@Mark S. great post to follow. What was the time frame on initial purchase to refi. I know this was during a huge boom era, but feel like it shows REI work they just take time and require thoughtful action.

Keep up the good work!

Hey Chris, 
Purchased first one in 11/2017 and fifth one in 1/2020.  Did DSCR cash out refi in 10/2021.  These were all turnkey.  A BRRRR without any effort on my end - I just got lucky.  

We have a couple others with the original 30 year fixed loans on them.  One is at 3.625% and the most recent (7/2022) at 6.375%.  Boy, how things can change quickly.  

This is a great example of small steps over and over and good timing! Looking back the DSCR refi's seem like a no brainer but back then some thought it was crazy.

Congrats and keep up the good work!

[Zach Edelman]

Can also save your DTI for future deals by going the DSCR route, as the loans do not typically (most true DSCR lenders offer this) get reported on your personal credit as long as you borrow with an LLC.