What are the risks of DSCR loans?

Question

I understand they have a little bit higher interest rate, but what are the risks of DSCR loans? Is there a demand clause where they can call the loans for no reason? My conventional loans don't have a demand clause. They can only call the loans due prematurity if I default.

I'm hesitant to give up my conventional loans on the next cash out refinance for DSCR loans. Thing is, I will need to go DSCR loans from here on out or just stop buying new real estate altogether.

Robin Simon · Answer

There certainly isn't really any more "risk" for DSCR Loans - no demand clause where loans can be called if you are current.  Maybe the biggest "risk" might be the fact that you cannot occupy the property at all so technically if you run into hard times and need to move into the property thats not intended - but no real more risk.  Generally, the biggest difference is that DSCR Loans often have prepayment penalties attached which typically will have a 1%-5% fee if you prepay the loan within the first five years so its the "risk" of having to pay a little extra fee if you sell or refinance the property pretty early on.

PS - check out this series of 10 articles published on BP on all things DSCR Loans which can give you a full rundown on everything you would need to know when using this type of loan!

DSCR Loans: What Are They And How To Get The Best Terms

https://www.biggerpockets.com/...DSCR Loans: How To Use Pro Strategies To Save More And Make More

https://www.biggerpockets.com/...Multifamily DSCR Loans: A New High-Impact Loan Option For Real Estate Investors?

https://www.biggerpockets.com/...12 Frequently Asked Questions (And Answers) About DSCR Loans

https://www.biggerpockets.com/...

8 More Commonly Asked Questions and Answers to DSCR Loans

https://www.biggerpockets.com/blog/eight-questions-and-answe...

What Documents Do You Need for a DSCR Loan?

https://www.biggerpockets.com/blog/what-documents-do-you-nee...

BRRRR Loans: What Are the Options, and How Do DSCR Loans Stack Up?

https://www.biggerpockets.com/blog/brrrr-loans-what-are-the-...

Short-Term Rental Loans: What Are the Options and How Do DSCR Loans Stack Up?

https://www.biggerpockets.com/blog/short-term-rental-loans-a...DSCR Loans: Terms to Know When Working With These Popular Rental Loan

https://www.biggerpockets.com/blog/dscr-loans-terms-to-knowWhat’s Next For DSCR Loans? Updates For 2024 and Beyond

https://www.biggerpockets.com/blog/what-is-coming-in-2024-fo...

Fernando Corona · Answer

Biggest risk with DSCR loans is to look out for the prepayment penalties. This means that if you pay off the loan too early, then you'll pay a 1-5% fee off the loan amount. paying off the loan early means you either refinance or you sell the property, both would trigger a prepayment penalty to the lender. that being said, you can choose your prepay options, 5yr usually giving you a better interest rate by like a 0.25%, 3yr being most common and standard, and a 0,1,2 yr where you can buy down the prepay to be less years. meaning you pay 1% upfront of the loan amount to get a 1yr prepayment penalty so you're free to sell the property or refi after 1yr.

Keep in mind that DSCR loans are how most investors have scaled. whether its residential DSCR or commercial DSCR at 5+ units. personally, i like them better. few reasons why:

1. seasoning period is only like 10-30 days vs 60days going conventional

2. seller max contributions DSCR is 3-6% where conventional its only 2% max

3. I can buy a 2-4 unit with 20% down vs conventional can only buy a 2-4 INVESTMENT property with 25% down

4. there are options where DSCR loans dont repot to personal credit, helps in not having to show a bunch of paperwork or not one person in a partnership has to carry the debt

5. way less paperwork to close on this loan type vs a conventional loan. we care about the income of the property you're buying and it's ability to service the debt of the property whether we use long term rents income, lease income, or air dna/bnb income.

6. easily buy in partnerships, add people to your operating agreement, its as easy as that so bring partners into a deal. helps with scaling and raising capital or getting partners involved

7. gift funds allowed to close on these as well, and like I said earlier, there's only a 10day seasoning period of funds with some lenders so that means you can literally have a private money lender deposit money into your account 11 days before closing, and you can use those funds to close! wild.

8. if you dont want to close in an LLC, you can still close in your personal name.

9. there are lenders with competitive rates if long term rents are greater than 1.1 of debt on the property (PITIA). however, there are also lenders who will allow you to do 80% cash out refinances with DSCR if DSCR ratio is 1.0. there are lenders that allow you to buy real estate at 20% down EVEN IF DSCR ratio is only 0.8. which means the rents are less than the debt on the property. Heck, there are even lenders that will NO DSCR, meaning they dont care what the income of the property is and they'll still fund the loan (at a lower LTV and higher interest rate of course).

So the goal of DSCR is now to figure out the best real estate cash flowing strategy to pair with DSCR loans as you scale your portfolio. anyone looking for help going DSCR, feel free to reach out as I build my portfolio with these and help investors scale theirs as a lender.

Fernando Corona · Answer

@Sheila Siegel go ahead and message me if you're still interested

Sheila Siegel · Answer

Hi Fernando....I'm a broker looking for a company that does DSCR loans with no or very little seasoning to allow for the value instead of the Purchase Price. Looks like you  may know who does those...please share!

Caroline Gerardo · Answer

Risks: rates go down and you have to pay a prepay of 2 or 3 %; you have to sell and pay the prepay; rents decline & you can't make the payment like any other type of loan; cost upfront a little more than conventional; need to find experienced broker licensed in the state where subject property sits; servicers are bulldogs.

John Morgan · Answer

@Jack B.

I love DSCR loans. I’ve done 5 of them. They’re quick n easy. All they ask for is your last two months bank statements. That’s it! The interest rates are usually .5% higher than conventional loans and you might have a prepayment penalty, but that’s the only negative I can think of.

Stacy Raskin · Answer

@Jack B., there's no more inherent risk if for an investment property. The same risks of investment property purchasing are the same whether underwriting the loan with your income or with the rents / DSCR ratio such as: 1. Overpaying for a property. 2. Buying a property without doing the proper inspections. 3. Inheriting nightmare tenants that are hard to move out. 4. Buying in an area with decreasing demand or property values.

There are prepayment penalties but many lenders let you choose from 1-5 years. The length of the term impacts the rate. More info below.

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+ generally gets best pricing for investment property loans with most lenders

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

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.

Erik Estrada · Answer

I would say the main risk is being aware of the prepayment penalty. It may trigger if you are paying down the balance aggressively during the prepayment penalty period.

Other than that, it is really a light doc loan with not many strings attached compared to a conventional mortgage. The fees and rate are generally higher on DSCR loans.

Jay Hurst · Answer

@Jack B.

There is no additional "risk" on the note like a demand clause etc, but you have  extra expense in upfront one time costs and the pre-payment penalty that most programs are sold with if rates do drop as expected in the future.

but, my my first question with these posts is why can you not use conventional financing anymore?  Do you have 10 properties financed?

What are the risks of DSCR loans?

What are the risks of DSCR loans?

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