Pros and Cons of DSCR Loans

So what are the pros and cons of DSCR loans? And is a DSCR loan the best option for you and your next investment property? So mortgage interest payments with a non-QM loan can be deducted each year on your income taxes. Obviously consult a tax advisor. You want to be able to do that anyways if you have investment properties, you have depreciation and all those different things that you want to potentially take advantage of if you can. There's a lot less documentation for DSCR loans and paperwork because we don't need your W-2s, your pay stubs, your taxes. We don't need any income documentation because we're utilizing the rental income to be able to qualify the property, not your income. So that also means that your debt to income ratio does not matter. I talked to some people that are like self-employed or they have a lot of rental properties. So yes, they have a lot of income coming in, but they write off a lot of things. So what they show on paper won't actually qualify them if they were to do a conventional style loan. You can close the loan in an LLC. There's interest only in 40-year loan options. So there's more flexibility in the product types and underwriting exceptions can be made unlike VA, FHA or conventional loans. Those are very strict in what the requirements are for a borrower to qualify and they won't go outside of that box. Again, a pro is no debt to income ratio. Now the debt to income ratio basically just compares how much debt you owe each month compared to your gross monthly income. And lenders use this DTI ratio to determine the borrower's level of risk if they were to take on additional debt like another housing payment. Now conventional lenders generally allow up to 45% debt to income maximum. And that ratio could be as high as 50% with strong credit score or large asset reserve. So if you can meet that requirement, you may not go with a DSCR loan. You might go with a conventional investment property. Conventional loan, I mean. The DSCR loan, again, it's based off the rental income. So lenders don't care about your personal income. They care about the current cashflow or projected cashflow of the investment property. So as long as the rental income is equal to or greater than the housing payment, which would be principal, interest, taxes, insurance and any association dues, then the most lenders will loan on that property if you meet the other requirements for credit score, down payment, all those factors. Now, if the property is not currently rented, then they'll use what the projected rental market analysis predicts what the rental income will be. Closing an LLC is a huge benefit, especially for investment properties because it protects you from personal liability. There's a lot of tax benefits to the LLC structure. It can ease the property transfer because you could actually switch the LLC over to another owner if you're passing this off to like a family member. And also, you can be anonymous as the owner because if somebody looks up the property, it's gonna show the LLC name, not your personal name. Because DSCR loans are non-qualified mortgages, there's a lot of different options, like a 40-year loan instead of a 30-year or interest-only options. Okay, so like right now, we're currently in a high-interest market. So you may love the property, but it won't cashflow with a traditional 30-year amortizing loan. So DSCR lenders have 30- and 40-year loan options with the first 10 years being interest-only payment, and then the remaining 20 years being a fully amortized payment. So that means the property could potentially ratio. And then within that 10 years, obviously, you could potentially refinance or you're paying more towards the actual balance if you pay up and above what that interest-only payment is. And then the goal would be to refinance into a lower interest rate down the road. So non-QM lenders use what's common-sense underwriting. It doesn't have to fit a very strict box. With conventional loans, the underwriter must check off all of the boxes for requirements, and the income of the rental property is calculated a very specific way, and there's no exceptions. Again, because DSCR loans are non-QM, they don't fall into this box, and the lenders can use common sense to justify if they want to make an exception on, let's say, a credit score, a credit event, or other factor that might get turned down by a conventional lender. For just an example that I ran into with some borrowers is one of the borrowers, they rent. They don't actually own a primary residence, but they were buying an investment property in another state, and one of their rental payments was not paid on time. It was actually technically 30 days late. However, the reason that it was late was their landlord moved, so they sent the check to the old address. The landlord still charged the actual 30-day late fee. What we did is we went to the landlord, and they wrote a letter of explanation stating that he was a great renter, had made payments on times for years and years, that he did move, and then the actual payments, we showed the history before, and then this borrower had very good credit score and a lot of assets, so the lender overlooked him being 30 days late technically on his rent. It's common sense underwriting is. But if this was like a VA, a conventional, an FHA loan, it doesn't matter. There's no way getting around those very specific guidelines. What are some of the cons of DSCR loans? Higher interest rates, higher credit scores are needed, higher down payments are required. There's minimum loan amounts. They can come with a prepayment penalty, and because they're doing a market rent analysis, there's not only the appraisal of the value of the property, but there's an appraisal of the rents, so that creates a higher cost in the appraisal. DSCR interest rates, lenders are loaning the money based on rental income of the property, and due to the fact that this is not a primary residence, it's an investment property, the loan is seen riskier for the lender, so rates for DSCR loans tend to be 1 1⁄2 to 3% higher than a conventional investment loan, but each scenario is going to be different. So you wanna make sure that you ask a lender or a broker exactly what the rate would be if you go the DSCR route, or if you went a conventional investment route, and then you can decide which way you wanna go, depending on if you can qualify for both. So DSCR lenders require, in most cases, a 660 minimum credit score, and for first-time investors, they may want over 700. Now, there are a lot of DSCR lenders out there, and some of them go down to 620, just like conventional loans, but it's just a handful, and these rates tend to make it tough for a property to be able to ratio out without you putting down a very large payment, like 40%. Okay, so the credit score required to be able to get you into a rate that will then make the property make sense as far as a cash flow and ratio scenario. Usually, 660 or higher is gonna be what's required. Have a lower credit score? Just give me a call. We can run through a scenario. I can quote it for you. We can see if the property ratios. No reason to give up just because you have a lower credit score. At least you can put yourself in a position of figuring out where you need to be in the future if you can't do an investment loan today. So the minimum down payment for most DSCR lenders is gonna be 20% down to purchase an investment property, and typically, they only go up to 75% loan-to-value on cash-out loans. Now, when the market wasn't so volatile, rates were not so high, I saw 15% down on purchases, even down to 10% at some times depending on the ratio of the property, and cash-out percentages, loan-to-values were higher. So depending on when you watch this video, these numbers might change slightly, and again, it really depends property to property, so we can actually price this out through an engine that'll tell you the max loan-to-value or the minimum down payment to make the property work. Now, conventional lenders are not allowed to have minimum loan amounts because it would be discriminatory regarding not being able to lend on certain types of properties or areas, but because these are non-qualified mortgages, DSCR lenders are able to be able to put a minimum loan amount, and most DSCR lenders require that the loan amount be $150,000 or greater. Now, I do have multiple lenders who do loans in the $100,000 range or $75,000 range, just not as many, so a lot of times you can't get as competitive a rate because there's less lenders that take those type of loans. You have to remember that these are investments for the actual, they're investments for you as far as the investment property and the cash flow, but they're also investments at the end of the day for the mortgage companies, and so if they perhaps have to foreclose on you, they're not making enough money on a $75,000 loan to have to then go through the foreclosure process, take that property over, try to sell it, so that's why they don't like these small loan amounts. Now, with DSCR loans requiring 20% down in most cases, this means that you should be looking at properties that are around $190,000 purchase price. You take $190,000, times it by 0.8 because you're putting 20% down, that would make your loan amount $152,000 because that's why I say that I recommend you being at $190,000 or more. Now, that might not be capable in certain markets and areas, so again, we can do the lower loan amounts, just know if you're out there on Google, you're looking at different rates, typically if it's a smaller loan size, you're going to pay higher fees or have a higher interest rate that comes with it. Another con is prepayment penalties with DSCR loans. They can be anywhere from a no prepayment with some lenders up to five years, so you want to make sure what you're getting quoted and the product that you're getting locked into. And prepayment penalties are going to come into play if you sell the property, refinance it, or even pay down the loan below a certain balance with some lenders, so you want to ask that if you plan on putting a large amount of money down on the property after you purchase it to pay down the loan. Now, the most common prepayment structure for DSCR loans is known as a step-down, and this is typically represented as like 54321, meaning that that's a five-year prepayment penalty. If you pay it off in the first year, you're going to pay a 5% penalty on the remaining mortgage balance. Second year, 4% penalty, third year, 3%. If it's a three-year prepayment penalty, the first year you're paying a 3% penalty, second year, two, third year, one. Now, if it's a fixed fee percentage, such as 555, this is indicating a three-year prepayment penalty, and regardless of when you pay it off in the three years, you're going to pay a 5% penalty on the remaining mortgage balance. Generally speaking, opting for a higher and longer prepayment penalty can lead to a lower interest rate from the lender, so you want to make sure that you ask for different scenarios, such as, can I look at a two-year prepayment penalty, a three-year prepayment penalty? A fixed prepayment penalty is going to have a better rate than a step-down, but do you really want a penalty that lasts for three years at 5%? So you have to weigh the pros and cons of that as well. Think about if you have an exit strategy on that property, or if you feel like, hey, I'm getting a rate when rates are really high right now, I feel like rates are going to come down over the next 12 to 18 months, I don't want to lock myself into a three-year prepayment penalty. Now, appraisal fees tend to be higher with DSER loans because they require an additional form to be completed by the appraiser to estimate the market rents of the investment property. This can add several hundred dollars to the appraisal fee, so just make sure that you ask the lender what the appraisal costs will be. Some lenders also can require a secondary, what's called a collateral desktop appraisal, or a CDA, in addition to the traditional appraisal in the 1007, just to verify the value in the market rents. And then there can't be a variation of more than 10% in most cases, or it could be needing a second true appraisal where they go out to the property again. Now, this is pretty rare, it's just the lenders protecting themselves, making sure that the appraiser isn't varying way off from what their team believes that the property is worth and what the market rents are worth. If you're a borrower that's unsure, if you want to go conventional or DSCR, we can run the numbers both ways to see if you can qualify conventionally. If you can, then we can compare the rates, and then you can decide which type of loan you want to move forward with. It's always good to know what all of your options are, especially in a higher rate market environment. You want to be able to get the best cashflow situation that you can. If you have any questions or scenarios that you want to run, you can scan this QR code, schedule a time, we can go through all of your options, answer all of your questions. You can also email me scenarios at trevorharborfunding.group, or you can shoot me a text or give me a call at 619-404-6637. If you like this video, make sure that you subscribe to my channel so you can see my other trainings, especially the ones that we dive into specific investment properties to see if they cashflow and will qualify for a DSCR loan.