The Impact of Rising Interest Rates on DSCR Loans

Long term rental loans, or DSCR (debt service coverage ratio) loans, have become popular in recent years for investors looking to buy and hold properties. Borrowers love them because these loan types allow them to qualify for a financing using their property’s cash flow rather than their income, and lenders love them because they can be highly accretive to their loan portfolios held for investment.

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It is no secret that when choosing an investment strategy, you need to consider many factors – risk tolerance, personal goals, diversification, etc. Especially important to consider is the current and near-term state of the economy, because rental property financing is relatively dependent on market economics – rising rates and decreased liquidity impact debt service, while high inflation and contracting growth impact rental housing affordability for tenants. 

2022: The Year of Rising Interest Rates

Mortgage interest rates dropped significantly during the COVID-19 pandemic and remained low through 2021, sending demand for properties through the roof. 2022, however, is a different story. Interest rates have increased sharply compared to previous years; the average rate for a 30-year fixed mortgage reached 3.5% at the end of January.

In early May 2022, to combat a 40-year high in inflation and attempt to restore price stability, the Federal Reserve raised its benchmark interest rate by half a percentage point. This hike pushes the federal funds rate to 0.75%-1%, and, according to CME Group data, current market pricing has the rate rising to 2.75%-3% by year’s end.

Impact on Lending

Until inflation slows, which very well could drag into 2023, lenders should be prepared to budget for continued increasing interest rates. What does this mean for different loan types?

Long term rental loans, or DSCR (debt service coverage ratio) loans, have become popular in recent years for investors looking to buy and hold properties. Borrowers love them because these loan types allow them to qualify for a financing using their property’s cash flow rather than their income, and lenders love them because they can help expand their investment in loan portfolios.

Due to rapidly rising interest rates, however, property mortgage debt is increasing as well, making it more difficult to meet the minimum DSCR requirements for borrowers. Because of this, we expect to see DSCR loans decline in popularity until interest rates even out again. In place of DSCR, we expect to see some lenders falling back to bridge lending with more competitive rates.

If you jumped into the long-term or short-term rental arena while DSCR loans were a hot commodity or are wondering how to transition your real estate investing business while utilizing conventional or bank financing, our team of experts is here to help. Our experienced Advisors have depth of knowledge and hands-on experience with various loan products and know the pros, cons, and business strategies associated with each. We would love to assist you with your real estate investment financing strategy and help you pivot to a new source of financing or capital to continue your portfolio growth and responsibly leverage your assets for stabilized returns.

Article By Melissa C. Martorella, Esq.

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