DSCR Lending Update

Private lending for long-term rental loans was extremely tough in the second half of 2022, and it’s not only because the interest rates had increased. In this article, I’ll explain what’s happening in the private lending industry as it pertains to DSCR long-term rental loans, what the current interest rates are, and I’ll also provide a few tips for real estate investors that are looking to obtain long-term financing for residential rental properties in 2023.

Lack of Liquidity

Obviously the increased interest rates are making it tough to close loans, but aside from higher rates, the lack of liquidity is the primary reason that it’s tough to get DSCR rental loans funded. And what I mean by lack of liquidity is the large institutional investors that used to buy pools of DSCR loans are currently out of the market.?

Almost all DSCR loans are sold to the institutional secondary market, then pooled in bulk and securitized as a bond. At this time, no public securitization deals are closing. The increased federal funds rate caused bond investors to focus on other investments that offer a similar yield.?

And many of those investments are rated securities. As of December 2022, the large rating agencies have not yet rated private lending securitizations, so we have a limited number of bond investors to recapitalize the lenders in our space.?

A few insurance companies have an appetite for long-term rental loans, but they only buy from the largest private lending companies. And some institutional capital providers are still buying DSCR loans on a selective basis and holding the loans on their balance sheet until the securitization market comes back, but balance sheets obviously have limits.

New Guidelines for DSCR Rental Loans

The lack of liquidity in the capital markets means that lenders have to tighten up their guidelines and only originate loans with the lowest risk. They are not considering any borrowers with average credit. The minimum FICO score for most lenders is 700. And for cash out refinances, some lenders are requiring their borrowers to have cash reserves. So the idea here is that they don’t want to lend to real estate investors that have no liquidity and want to use the equity from their rental property to pay for living expenses.?

Most lenders are maxing out a 75% loan-to-value for DSCR rental loans. In the past, the maximum was 80% LTV. Some lenders are rejecting DSCR loans for rental properties in markets that are experiencing large home price declines.?

Many lenders are avoiding short-term rental properties located in secondary and tertiary markets, unless the investor operates multiple STR properties. Investors that are new to short-term rentals may have a tough time getting financing, and/or they will pay a much higher interest rate.?

DSCR Interest Rates

As of early January 2023, interest rates for DSCR rental loans are ranging from 7.5% to 9.25% for most lenders. The good news is most lenders don’t expect DSCR interest rates to increase much in the near future, even if the Federal Reserve increases rates during the first quarter of 2023. The bad news is most lenders don’t expect rates for DSCR rental loans to come down any time soon.?

Tips for Rental Investors in 2023

One way to reduce the interest rate is to buy it down by paying a higher origination fee. For example, if you get a quote for 7.5% plus 2 points origination fee, the lender may reduce the interest rate by 0.25% or 0.5% if you were to pay 3 or 4 points in origination fees.

And you may want to consider a shorter loan term. In addition to a 30-year term, many lenders are now offering a 5-year loan term, but the prepayment penalty is always a concern with all long-term rental loans. If you’re anticipating that the interest rates for DSCR loans will come down in the next 2 years and you can eventually refinance with a lower rate, you may be thinking of getting a short-term bridge loan for 2 to 3 years instead of a long-term loan with a big prepay penalty.?

One solution to this dilemma is to buy down the prepayment penalty with a higher interest rate. For example, if you receive a quote for 7.5% with a 3-year prepayment penalty, you could possibly increase the rate to 7.75% or 8% in exchange for a 2-year prepay. The higher rate for the long-term loan will most likely be 1% to 3% lower than the interest rate for a short-term bridge loan.

Interest rates and guidelines for DSCR loans are still changing quite frequently these days, but many lenders are still actively closing deals. You can find many active direct lenders on our website, PrivateLenderLink.com.?

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