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Real Estate Investing is far from easy and simple. This is true no matter what the long list of “gurus” and experts, podcasters, social media moguls or any of the other cast of characters who permeate the internet today say. However, that doesn’t mean that real estate investing isn’t a powerful and doable path to enormous wealth and financial freedom. It has been for several decades and will likely continue to be. And utilizing the power of leverage and optimal financing strategies remains a huge part of charting a successful path to wealth. At the end of the day, getting the best DSCR Loan terms on financed rental properties are absolutely critical for real estate investing success.
Before diving into how to get the best loan terms, let’s start with defining what exactly that means. Generally, “best loan terms” mean the lowest overall cost (combination of both lower rate and lower closing fees) while also accounting for the structure of the loan and associated provisions. One of the big benefits of DSCR Loans is that because they are made by private lenders (who create their own pricing, structures and options and aren’t beholden to agency rules and regulations), there is much more freedom and flexibility for customization to investor preference. This is great for investors because some loan structure and pricing options are neither “good” nor “bad;” rather, they can be tailored to individual investor need.
Some examples of this concept are prepayment penalties, where one investor who plans to buy and hold for the long term will gladly take a severe prepayment penalty provision (i.e. 5% fee for first five years of the loan) for an interest rate 1% less over the life of the loan (i.e. 6% instead of 7%), while a second investor who likes to refinance or buy and sell properties frequently would prefer the higher rate without having to worry about any fees if they decide to refinance or sell the property quickly. In addition, there is lots of opportunity for investors to choose whether they prefer costs “upfront” in the form of higher closing fees to “buy down” the rate, or prefer to minimize costs to close and pay more over the life of the loan in the form of interest. Investors can often get a significantly lower rate if they “buy down” points and typically have lots of options to choose from.
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For example, a DSCR Lender may offer three quote options for a $500,000 loan:
Again, the beauty of DSCR Loans is their flexibility. None of the above options is necessarily better or worse than the others. It all depends on the preferences of the individual investor.
What goes into those numbers? DSCR Lenders are businesses, not charities, and while they provide a very valuable service in offering financing to real estate investors, they need to make money too. And DSCR Lenders earn their money chiefly through interest rates and closing fees. This is commonly referred to as “pricing the loan,” best thought of as assigning a price, in this case a combination of rate and closing fee, to a specific DSCR Loan.
What determines the price? DSCR Lenders price the risk of the loan, essentially offering higher prices (i.e. higher rates/fees) when there’s a higher risk of the loan defaulting, and offering lower prices (i.e. lower rates/fees) if there’s a lower risk of the loan defaulting. Evaluating this risk is referred to as underwriting the loan; which is the process of determining the overall risk of the deal by evaluating multiple factors together.
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Note that pricing and underwriting are distinct functions. Underwriting measures the risk; pricing then assigns a rate/fee to the risk. Additionally, pricing, or the determination of rates and fees, is made up of two key pieces: 1) the underwritten risk of the deal and 2) the market rate of mortgage loans in general. This chapter will focus on the first aspect of pricing, the underwritten risk of the specific loan, and how these risks are evaluated. Fortunately, they are in large part under the control of the borrower/real estate investor. While the second piece, market rates, are important, they are generally out of the control of both the borrower and the lender. Regardless, market interest rates are important to understand, and will be covered in Chapter 9.
While the purpose of this guide is to explore all the nuances and insider knowledge to optimize the trickier and more advanced aspects of real estate investing finance, at the end of the day, financing rental properties by utilizing DSCR Loans to supercharge returns is mostly straightforward. It generally follows the tried-and-true pareto principle (or “80/20 Rule”), which posits that the a small portion of the factors (~20%) are responsible for 80% of the effect. This applies to DSCR Loans too. In our case, when searching for the best loan terms (i.e. lowest interest rate and lowest fees), a small portion of the factors (chiefly, your credit score, LTV ratio and DSCR ratio), determine the vast majority (~80%) of the pricing, or rate and terms (excluding overall market factors outside of anyone’s control). While optimizing the remaining ~20% is important for becoming a top-tier investor in terms of financing; getting a rock-solid understanding of what really moves the needle is the paramount first step to mastering DSCR Loans as a tool for achieving financial freedom.
Read Next: Learn the "Big Three" Factors that are key in determining your interest rate and terms for a DSCR Loan, FICO, LTV and of course, DSCR!
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