In today’s market investors have two main options for long term investment property financing DSCR and commercial financing. Below I’ll break down the ins and outs of each option and what you need to know before financing your next buy and hold project.
Let’s start with commercial financing, the term itself is something most investors are leery of. Most investors have the preconceived notion that commercial financing only applies to large industrial projects. However commercial or investment financing refers to any type of loan that is non owner occupied and intended to be used for investment or commercial purposes. Not all commercial lenders are created equal, that’s why working with a broker can be advantageous as the broker will sort through the financing options and negotiate terms on behalf of the borrower.
Commercial financing is typically very vanilla but can be customized to suit the project depending on size and complexity. For now, let’s focus on the basic terms of commercial financing. A commercial loan will require full underwriting of all guarantors or borrowers in the project. With that the lender will request at least two years of tax returns, commercial debt schedules, rent roll, a personal financial statement, and a credit bureau. For tax savvy investors, self-employed individuals, or those with high credit utilization, commercial financing may be more difficult to qualify for. The lender will underwrite the project level cash flow, each borrowers’ personal cash flow, and a “global cash flow” or combined cash flow, to ensure that the borrower meets bank and regulatory standards. Typically, commercial lenders require the project, borrower, and global cash flow to produce a debt coverage ratio of at least 1.20x or greater. If the borrower qualifies for financing, the lender will provide terms to the borrower. Below is a breakdown of terms that I recently received for commercial financing.
Loan amount: $300,000
Term: 5-year Balloon
Amortization: 20 Years
Rate 5.5%
Monthly P&I $2,063.66
With the commercial financing terms outlined above the borrower is getting a fixed rate of 5.5% with a 10 year term. The loan will be amortized or paid off in 20 years. However, with this loan option the borrower will have to refinance in 5 years. If interest rates are significantly higher in 5 years the borrower may be in for a surprise when their loan matures and they’re required to refinance. On the other hand, if interest rates are lower the borrower has the opportunity to refinance at a lower interest rate and re amortize their remaining balance for an additional 20 year term.
The other long term investment property financing option would be a DSCR loan. With this loan the lender is not collecting or underwriting financials from any of the borrowers or guarantors of the property. Instead the lender reviews the property’s ability to service the Principal, Interest, Taxes, and Insurance or (PITI). If the property can cash flow the PITI and the borrower maintains the down payment and credit score requirement the lender will likely approve the loan through their investor DSCR program. DSCR loans are great for tax savvy investors, self employed individuals, and very aggressive real estate investors. Below are DSCR terms I recently reviewed for the same $300,000 scenario that was listed above.
Loan amount: $300,000
Term: 30 Years
Amortization: 30 Years
Rate: 7% Fixed
Monthly P&I $1,995.91
With DSCR financing the borrower is paying a higher interest rate but getting a fixed rate for the entire term and amortization of the loan. If interest rates are significantly higher over the life of the loan the investor has locked in their interest rate eliminating future interest rate risk. If interest rates decline, the investor can always refinance. The biggest draws to DSCR financing are the 30 year term and amortization along with the simple qualification guidelines.
In todays rising interest rate environment borrowers are interest rate and cash flow conscious. The difference in the monthly payment between the two options above was $67.75 a month. Borrowers should be cognizant that the terms and structure of their loan are just as important as the interest rate. If you would like to find out more about commercial financing, DSCR financing, or if you would like to discuss a project, give us a call and speak with one of our loan officers today 614-362-8701.
Zac Armstrong
Focus DSCR, inc.
614-633-8744
Disclaimer: Not Financial or Investing Advice
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