When you invest in real estate, there are numerous strategies you can implement to improve cash flow and gain enough money to make additional investments. One method that has proven popular among investors involves refinancing rental properties to get the cash needed to invest in other rentals.
With this strategy, you can quickly grow your portfolio and build your wealth. You can also refinance if you want to reduce your interest rate. Your ability to refinance your rental property depends on the type of loan you used to buy it. If you buy your rental property with a fix-and-flip loan, you can eventually refinance it with a DSCR loan. This is the ideal financing strategy for BRRRR investors.
With this strategy, you can quickly grow your portfolio and build your wealth. You can also refinance if you want to reduce your interest rate. Your ability to refinance your rental property depends on the type of loan you used to buy it. If you buy your rental property with a fix-and-flip loan, you can eventually refinance it with a DSCR loan. This is the ideal financing strategy for BRRRR investors.
What Is a DSCR Loan?
A DSCR loan allows investors to purchase residential homes that can be rented out for monthly income. This mortgage loan can only be obtained for income-producing properties. Investors often choose this loan because it comes with looser lending requirements.
While your credit score will still be assessed, you don’t need to show tax returns and W2 statements. Lenders care more about the kind of cash flow the property will provide. Like most types of mortgage loans, it’s possible to refinance your property with a rental DSCR loan.
Whether you bought your property with a fix-and-flip loan or cash, you can refinance it for a longer term and lower interest rate after rehabbing it. Once this mortgage loan is in place, you can move to your next investment.
If you refinance with another type of loan, you’ll need to provide proof of income, which requires pay stubs and tax returns. DSCR loans focus entirely on your rental property’s cash flow. Your ability to qualify for this loan depends on your current debt service coverage ratio (DSCR). A positive ratio means that you can use your rental income to cover the loan payments.
Keep in mind that there’s no limitation on the number of DSCR loans you can request. If you own numerous real estate properties, you can apply for multiple DSCR loans to give you access to more cash.
How to Calculate Your DSCR
Before you attempt to refinance your property with a rental DSCR loan, calculate your ratio. Lenders often accept ratios of 1.0 or higher. Use the following formula to make this calculation:
Monthly Rental Income / PITIA Expenses (Principal, Interest, Taxes, Insurance, and Association Fees)
Your loan amount and DSCR ratio are impacted by your rental rates, property taxes, insurance payments, utility payments, and interest rate. Less debt usually leads to a higher loan-to-value ratio and a lower down payment.
When to Refinance Your Rental Property
Refinancing your rental property can be highly advantageous if you want to use the BRRRR strategy, which stands for buy, rehab, rent, refinance, and repeat. If you have higher credit since you obtained a fix-and-flip loan, you can use a refinance DSCR loan to reduce your interest rate. A lower interest rate means that your rental property income should increase.
If you already have a traditional mortgage, refinancing a DSCR loan allows you to use the cash to buy other investment properties. When you obtain a cash-out refinance loan, the money you receive comes from your equity. While many investors use these funds to finance a new real estate investment, you can also spend the money on repairs and renovations.
Some refinance options alter the entire loan term. For example, the standard term for a DSCR loan is 30 years, which means that it will take 30 years for you to repay the entire loan amount. When you refinance, you may be able to request a shorter loan term. In this scenario, you could switch from a 30-year term to a 15-year one, which will allow you to repay the loan faster. During this process, you can even change a fixed-rate loan to an adjustable-rate one.
Pros and Cons of Refinancing a DSCR Loan
Refinancing a rental property DSCR loan comes with its share of pros and cons. The main advantages of applying for a refinance include the following:
- Stricter lending requirements that might require a higher credit score
- Considerable closing costs
- Potential for higher interest rates
DSCR Lending Requirements
If you already have a DSCR loan, refinancing it shouldn’t be too difficult. However, there are some basic requirements you’ll need to meet. While DSCR guidelines aren’t as strict as conventional lending requirements, they are standardized across most lenders. To qualify for a refinance, you’ll be tasked with meeting the following requirements:
- Minimum loan amount: Around $75,000
- Minimum DSCR: 1.0
- Maximum LTV ratio: 75%-80%
- Bank statements: 3-6 months
- Minimum credit score: Around 600
- W2 statements and tax returns: No
The maximum loan amount is usually around #3 million. Before applying for a DSCR refinance, make sure you won’t incur a sizable prepayment penalty. DSCR loans often come with prepayment penalties, which means that paying off your loan too early can be costly. This fee requires you to pay a declining percentage of the outstanding loan balance for each year of the penalty period, which could last for three or five years.
Refinancing your rental property DSCR loan gives you the opportunity to convert a fix-and-flip loan into a traditional mortgage or gain access to the equity you’ve built up in your rental. If you have questions about how this loan works and what the application process looks like, contact LoanPathLoans today to speak with an experienced real estate professional.
