7 Factors Lenders use to Calculate DSCR Rates
What are the 7 Factors Lenders Use to Calculate Your DSCR Interest Rate?
When seeking a DSCR (Debt Service Coverage Ratio) loan, it is essential to understand the factors lenders use to determine the interest rate they are willing to offer. Here are the seven major factors that could influence your DSCR loan rate:
1. Loan to Value (LTV)
The Loan to Value ratio compares the property value or appraised value to the loan amount. For instance, if your property is valued at $200,000 and you have a loan of $150,000, the LTV would be 75%. As the LTV approaches 100%, the risk to the lender increases, resulting in a higher interest rate. Most lenders will loan up to 80% on a purchase, with some extending to 85% if your credit score is 720 or higher. The minimum down payment is largely driven by your credit score.
Typical loan-to-value buckets for lenders would be:
75.01-80 LTV
70.01-75 LTV
65.01-70 LTV
60.01-65 LTV
50.01-60 LTV
<=50 LTV
This means a property with a loan-to-value between 70.01 and 75 will fall into the same rate adjustment. Each lender will have their own adjustments and minimum credit scores based on their risk tolerance.
2. Credit Score
Your credit score is a critical element in determining the rate. Some lenders may approve loans for credit scores as low as 600 but will require a much larger down payment, often around 35%. Typically, lenders prefer a credit score of 680 or higher to allow for as little as a 20% down payment on a DSCR loan.
3. Loan Purpose
The purpose of the loan—whether it's for a purchase or a refinance—affects the interest rate. If it's a refinance, lenders also consider whether it's a rate and term refinance or a cash-out refinance. Cash-out refinances often have higher rates because they present more risk to the lender, suggesting the borrower needs cash. Therefore, the amount of money you wish to pull out will affect the rate you qualify for.
4. Property Type
Lenders consider the type of property being financed. A single-family residential home is deemed the safest investment, whereas multifamily homes (two, three, or four units), condos, condo-tels, and townhouses might come with varying interest rates. These property types can influence your interest rate depending upon their perceived risk.
5. Prepayment Penalty
DSCR loans often come with prepayment penalties, ranging from no penalty at all to penalties extending up to five years. The longer the prepayment penalty period, the less risk there is to the lender, which can result in better terms and interest rates. However, a longer prepayment penalty period can pose significant constraints, so carefully consider your options here.
6. Investor Experience
Lender terms can also be influenced by whether you are a first-time investor or have experience. Experienced investors who currently own rentals or have successfully flipped properties in the past 18 months may find better rates. First-time investors may still find lenders willing to work with them but often face slightly higher rates due to the increased risk.
7. DSCR - Ratio
The DSCR ratio itself is perhaps the most significant factor. Lenders look at the ratio of rents or projected rents to housing payments, which includes property taxes, insurance, and association dues. A 1:1 ratio (or 1.15) is typically the baseline, resulting in higher rates if the DSCR ratio is at its minimum standard. Conversely, a ratio of 1.5 or higher often yields better rates.
Understanding Par Rate and Discount Points
You don't qualify for just one rate but for a par rate—the base rate offered without paying discount points. Discount points allow you to lower your interest rate by prepaying interest. It’s crucial to calculate the benefit of this based on your projected holding period for the property. If the cost to buy down the rate doesn't pay off before you sell or refinance the property, the discount points might not be worthwhile.
Navigating DSCR loan interest rates requires a thorough understanding of these factors. Collaborating with a knowledgeable mortgage broker can help you evaluate all your options and make an informed decision tailored to your investment goals. If you have specific scenarios or questions, feel free to reach out for personalized advice and loan options.
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