Many single-family real estate investors prefer to purchase properties in the name of a limited liability company. This protects them from lawsuits and keeps their investing business apart from their personal names. For these investors, local and regional banks have historically been the best resource for refinancing loans secured by their 1 to 4-unit rental properties — that is, until recently when the landlord loan emerged as a competitive alternative.
A surprising consequence of the COVID-19 pandemic was an increase in real estate prices. Another surprising consequence was that the cost to borrow for investors went down. A landlord loan product called a DSCR loan has gained popularity among real estate investors. DSCR loans, based on debt service coverage ratio underwriting, offer competitive pricing compared to local bank loans. These loans are rapidly capturing significant market share from traditional local banks
DSCR Loans
DSCR loans were designed with the single-family real estate investor in mind. Investors often buy in LLCs, which this product permits. Investors are often self-employed, and their tax returns are difficult to decipher — this product does not require a tax return review. For income verification, DSCR loan underwriting focuses on the rental income (in-place or potential) that the property can produce.
The underwriter calculates a Debt Service Coverage Ratio after accounting for property taxes and insurance costs. This ratio plays a key role in determining the pricing of the DSCR loan product. DSCR lenders require a full interior 1004 form appraisal to assess the property’s value and condition.They also request a 1007 Single-Family Comparable Rent Schedule to evaluate current or potential rental income. The loan product is full recourse to the members of the LLC that owns the property. A borrower’s FICO score is another significant factor influencing the loan’s pricing.
Investors prefer DSCR loans over local bank loans due to their competitive interest rates and flexible terms. DSCR loans feature a simpler underwriting process that removes the need for extensive financial documentation. Borrowers can typically receive pre-approval for a DSCR loan within just a few hours. Lenders often close DSCR loans in days once they have the necessary appraisal and title work completed.
DSCR loans can come with many features around loan terms, amortization, and prepayment penalties. The 30-yr fully amortizing DSCR loan is probably the most popular. Cash-out refinances are available, and with the increase in real estate values over the past few years, many investors are taking the opportunity to tap some of their equity and lock in rates at today’s still historically low levels.
Looking to the Future
DSCR loans have existed for years, but the rates weren’t very competitive pre-COVID and so banks reigned supreme as lenders to Main Street real estate investors. With newly competitive rates and terms designed for investors, the DSCR loan has been making a splash in the single-family investing space. And with banks struggling to ‘find their place’ in this rapidly evolving financial world, DSCR loans may be another example of the disruption that soon becomes the ‘new normal’.
