Loan Purpose for DSCR (Rental Property) Loans: Does it Matter?

[Robin Simon]

Adapted from a twitter thread (@RobinSimonESC), thought I'd share here!

"DSCR Loans" are popular investment property mortgage loans for real estate investors, perfect for people that struggle to qualify for conventional financing (no W2, stretched DTI), hate intrusive documentation or are ready to SCALE (buy lots of properties, fast). Qualification for a DSCR loan is almost completely based on the property rather than you, the borrower. Outside of running credit and making sure you have a few months of payments in the bank, the rate/structure/points and qualification will be based on the real estate

Pricing generally is driven by the big 3 metrics: 1) Credit Score, 2) DSCR (debt service coverage ratio) and 3) LTV (loan to value ratio). However, there are few other "levers" that can have a huge effect on your interest rate. One of these is Loan Purpose.

Generally there are three buckets for "Loan Purpose" in DSCR Loans 1) Acquisition 2) Rate-Term Refinance 3) Cash-Out Refinance

Acquisitions are the simplest. This is a loan for purchasing an investment property. Refinances are when you are taking a loan on a property already owned, either using the new loan proceeds to pay off a prior loan (or simply taking a loan out on a property you own free & clear.  Whats the difference between Rate-Term Refinance and Cash-Out Refinance? Lenders may differ slightly, but it generally means if you are getting cash in your pocket at closing (New Loan > Old Loan + closing costs/escrows). We define anything >$2k a cash-out.So why does it matter? Loans with Purpose of "Acquisition" will have an interest rate that is generally 50-100 bp BETTER than a cash-out refinance (i.e. 6.5% instead of 7%). Main reason for this? The lender can trust the value much better. The best indicator of value is "market price" - i.e. the highest amount the property would go for in an open market. By definition, an acquisition loan will be on a property that is being purchased at exactly market price, so lender can be comfortable w/ value risk.

For a Cash-Out Refinance - a value is determined by an independent appraisal, but at the end of the day its just an imperfect guess, making the deal riskier for the lender (risk made an error on a property overvalued by "expert" opinion).  In addition, the investor has more "skin in the game" on an acquisition - psychologically, someone who just plunked down 20%+ in equity is going to do what it takes to not default and keep the property. Someone who has no equity in the property probably won't fight as hard...

What about "Rate-Term Refinance"? These are actually priced like Acquisitions rather than cash-outs, primarily due to the "skin in the game' factors mentioned above. Someone not taking any cash out (or putting MORE cash/equity into the property) should be less likely to default.  Bottom Line - as a real estate investor, its helpful to learn the "levers" that will determine the terms of the loans you are eligible for, and hopefully this is a helpful insight into how Loan Purpose affects your rate!