With interest rates on the rise, investors are starting to re-evaluate exit strategies for their flip properties. As the market moves further into uncharted territories, one thing has been certain – rising rents. This has presented many investors with the opportunity to create passive income by refinancing their properties into a long-term loan product.
There are several lenders in the private lending industry, such as Coastal Equity Group, that offer long-term financing for rental properties. Whether you have a short-term rental or a long-term lease in place, there are options to refinance into a DSCR loan giving investors the opportunity to hold a property under your business entity as a rental property.
We’re going to breakdown how lenders evaluate your property and what to consider when deciding whether or not to refinance into a DSCR loan.
Factor 1 – Appraisal Reports
There are several numbers that need to be considered when evaluating a refinance. Including the purchase price, current loan payoff, the as-is value, and market rent. In many cases, a lender will start the refinance process by getting an appraisal report completed to determine the current as-is value. The As-Is value is a key component used to determine your max loan-to-value (Total Loan Amount/As-Is Value). Also included in the appraisal report will be a market-rent analysis. This will part of the appraisal will determine the market rent for your property based on comparable rental properties, usually located within 5 miles of your property. The market rent for your property will be one of most important figures used to calculate DSCR.
Factor 2 – Seasoning Period
For investors interested in refinancing their property, it’s important to understand when you can start the refinance process. Many lenders require the borrower to hold the property for a certain amount of time enabling the property to gain equity. A seasoning period starts from the day that a borrower officially acquired the property (date of purchase) or on the date of the most recent financing. Typically, seasoning periods are 3, 6, or 12-months from this date.
Factor 3 – Current Loan Balance
In almost every refinance, the lender will be assuming first position. At the time of closing, a lender will pay off your current loan balance from your previous debt holder. Depending on the payoff amount, this will determine whether you will receive cash from the transaction or will need to come out of pocket to cover the difference between your new loan amount and current payoff.
Factor 4 – Credit Score
Your credit score will be the main determining factor that will dictate your eligibility for the loan, leverage, and interest rate. As the market continues to shift, lenders have become more conservative with borrowers’ qualifying credit scores. As a lender, we are starting to see the minimum credit score for a refinance to be as low as 650.
Factor 5 – DSCR – Debt Service Coverage Ratio
Lenders use this ratio to determines a property’s available cash flow or operating income to pay for its debt obligations. A lender will have a minimum DSCR that must be met as this number gauges the borrower’s ability to repay the monthly debt. Some lenders will require 1.1, but we have seen as low as 0.9. So, how do you calculate your DSCR? In residential lending, you’ll take your gross month rent(s) divided by your monthly PITA (Principles, Interest, Taxes, Insurance, and Associations). For an in-depth overview, please refer to our YouTube channel where we break down how to calculate your DSCR.
Together, these factors and numbers help lenders evaluate a borrower’s eligibility for a long-term loan such as a DSCR loan whether it’s for a rental acquisition or refinance. We hope this article provided clarification on the process and the property numbers to look out during this process. If you have any questions regarding your eligibility for a DSCR loan, please connect with a Coastal Equity Group team member today!