Posted: September 7, 2023

DSCR Loans Glossary – Terms to Know when working with Rental Property Loans

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This article was originally published September 4, 2023 on BiggerPockets.

 

Navigating the world of financing rental properties can be overwhelming for even experienced real estate investors. There are tons of terms, phrases, and acronyms that can cause confusion, and real estate finance is also notorious for misnomers and multiple terms that all mean the same thing.

 

To help investors master the world of DSCR loans and know how to effectively communicate and work with rental property lenders, here is a helpful glossary of terms you need to know to understand investment property mortgage lending like a pro.

 

 

Types of Rental Property Lenders

 

While a lot of these aren’t official and can have some overlap, here are the types of lenders that you will encounter when getting loans for your rental properties:

 

Non-QM lenders

 

These are lenders that provide mortgage loans, both for owner-occupied and non-owner-occupied (rental properties), that do not qualify for CFBP mortgage requirements, which generally are defined as loan requirements for purchase by government-sponsored enterprises (GSE). Qualifying mortgage loans typically require stable W-2 employment and DTI ratio requirements, so non-QM lenders primarily serve homeowners who are self-employed or employed as 1099 contractors, non-U.S. citizens, and real estate investors.

 

DSCR lenders

 

These are private lenders that lend a specific loan product—DSCR loans—and these lenders only provide loans for investors. These lenders have proprietary guidelines that do not have to confirm to GSE agency guidelines. DSCR lenders strictly serve real estate investors, particularly those investors who are scaling past a couple of properties (and thus struggle to qualify for conventional loans), or those who are pursuing innovative strategies such as the BRRRR method, short-term rentals, and multifamily investing.

 

Banks

 

While many real estate investors use the term “bank” to describe all lenders that offer rental property loans, banks should be differentiated as financial institutions that operate under strict licensing and regulatory requirements.

 

Conventional lenders

 

These are lenders, including banks and lenders that can also offer non-QM loans, that primarily focus on qualifying mortgages or loans that follow the standardized GSE requirements.

 

Private lenders

 

Private lenders should be defined as mortgage lending companies that are not non-banks (and thus not subject to banking regulations and licensing requirements) but also have all the infrastructure of a lending company (including necessary licensing, infrastructure, and capital). Private lenders primarily focus on serving real estate investors and can be much more forward thinking and flexible than heavily regulated and standardized peers (such as banks and conventional lenders).

 

Private money

 

The term “private money” should be differentiated from private lenders. Private money generally refers to individuals who invest in real estate through lending personal capital, rather than as a full-fledged lending company.

 

Hard money lenders

 

Hard money lenders are typically private lenders that typically lend on higher-risk real estate projects, such as properties that need heavy rehab or for borrowers that have challenged credit. These loans are typically of short duration and have higher interest rates and fees, and aren’t used for stabilized properties.

 

While these definitions are distinct, there is much overlap between the lending types, where one lender can fall into multiple categories. Common examples of this include private lenders that are both DSCR lenders and hard money lenders, or banks that offer conventional and non-QM mortgage loans.

 

 

 

Rental Loan Acronyms to Know

 

Many industries can be intimidating to newcomers, as a flurry of acronyms is tossed around when people first dive in. Unfortunately, the rental property loan space is guilty of this. Here are some helpful definitions to illuminate commonly used terms to know.

 

ARV: After-repair value

 

After-repair value is the value that is estimated for a property after planned renovations are done. It is typically done at the beginning of a renovation project (such as when doing the fix-and-flip or BRRRR method strategies) by a hard money lender, and determines how much will be lent.

 

DSCR: Debt service coverage ratio

 

This is the ratio of the revenue from the property, divided by the expenses associated with the property. A DSCR ratio of 1.00x means a property that is “breaking even,” or revenue equals expenses. A DSCR ratio greater than 1.00x means the property is “cash flowing,” whereas a DSCR ratio less than 1.00x means the property is “losing money” every month.

 

Note that for DSCR loans, the DSCR ratio is calculated as rent/PITIA, while DSCR ratios for commercial real estate loans is typically calculated as net operating income (NOI)/debt service.

 

ARM: Adjustable rate mortgage

 

This is a mortgage loan in which the rate is not fixed throughout the entire term. Many rental property loans, particularly DSCR loans, that are ARMs are better described more as a “hybrid (fixed-to-ARM)” structure, where the rate is not floating throughout the entire term; rather, it is fixed for an initial period (typically five or seven years) before then floating on a designated schedule.

 

Typically, DSCR ARM loans are described with two numbers in shorthand, such as “5/1.” The first number refers to the initial fixed-rate period, and the second number refers to the frequency that the rate adjusts—in this case, every “one” year after the first five years of the term.

 

LTC: Loan-to-cost

 

This ratio measures the loan amount compared to the cost of the purchase and any renovations to the property. Note that it is distinct from LTV (loan-to-value), which represents the ratio of the loan amount to the value of the property.

 

One of the foundational cornerstones to building wealth in real estate is that the end value of the property is greater than the costs put in (“forced appreciation”), so whether doing the BRRRR method or fixing and flipping, the goal should have a LTC higher than LTV.

 

LTV: Loan-to-value

 

This is a key metric in rental property loans, comparing the loan amount to the value of the mortgaged property.

 

MTR: Medium-term rental (or ‘midterm rental’)

 

This refers to investment properties that offer stays for greater than 30 days but less than full-year leases. Typically, these are aimed at traveling nurses, families displaced from a home renovation, or academic professionals, and have 30-to-60-day stays. These fall in between short-term and long-term rentals.

 

PITIA: Principal + interest + taxes + insurance + HOA

 

This acronym is for the standard monthly payment on DSCR loans. The principal and interest part represents the debt service payment to the lender, while taxes, insurance, and HOA dues (if applicable) represent payments on important expenses that are often collected and escrowed by lenders. The “taxes” in PITIA refer to property taxes, while “insurance” refers to property insurance (and flood insurance, if applicable).

 

PUD: Planned unit development

 

This refers to a property that is generally a stand-alone home but part of a community, typically with an HOA and monthly dues. PUDs may also have usage rules that would not apply to standard single-family homes.

 

RTL: Residential transition loan

 

This is a term typically for hard money loans used for renovations and rehabs of properties (transition from distressed to stabilized). This term is typically used more in financial and securitization circles, but referred to as hard money or bridge loans among investors.

 

STR: Short-term rentals

 

This is becoming the standard term for short-stay investment properties, generally offered for stays less than 30 days, but typically for weeklong stays or less. While a lot of investors use STR interchangeably with Airbnb, many real estate investors have transitioned to preferring the STR term to better encompass the strategy, particularly as people operate their properties on multiple platforms.

 

Bonus: SFR: Single-family rentals or single-family residence?

 

This has become a confusing term in real estate lending, as nobody seems certain if the popular SFR term means a single-family residence or a single-family rental. While they seem the same at first glance, there is a pretty strong distinction in that rental implies a non-owner-occupied property, whereas a single-family residence could include any housing stock that is one unit. It’s important to note this distinction when dealing with lenders.

 

 

 

Other Rental Loan Terms to Know

 

The following are additional examples of terminology that will definitely benefit real estate investors. Some of these terms are particularly noteworthy because they can mean different things with the same term or have many different meanings in other industries and contexts.

 

Blanket loans

 

These kinds of loans are one loan secured by multiple properties. Sometimes these are also called “portfolio loans.”

 

Cash-out refinance

 

This is a refinancing transaction where the borrower receives $2,000 or more at closing (after taking into account payoffs of any prior debt, escrows, and closing costs).

 

Cost basis

 

This term refers to the amount of money invested by the real estate investor into the property, typically the purchase price plus the renovation costs. Many lenders will have requirements and limits around lending past cost basis on cash-out refinances with short seasoning periods.

 

 

Prepayment penalties

 

These are provisions in rental property loans that require borrowers to pay a penalty if the loan is prepaid (partially or in full) prior to the end of the term.

 

A key distinction between DSCR loans and conventional loans or non-QM loans on owner-occupied properties is that DSCR loans typically come with prepayment penalty provisions, while those are not allowed or offered for the latter loan types. Typically, for DSCR loans, these penalties will have a “descending” structure and will simply be an extra fee equal to a certain percentage of the remaining loan balance.

 

Common structures are “5/4/3/2/1” or “3/2/1,” where each number represents the percentage fee for a year. For example, 5/4/3/2/1 refers to a 5% penalty if prepaid in year 1, 4% if prepaid in year 2, 3% if prepaid in year 3, 2% if prepaid in year 4, and 1% if prepaid in year 5. Then, assuming it’s a 30-year mortgage loan, any prepayment made in the last 25 years of the term would have no associated penalty.

 

A few more important things to note on prepayment penalties is that larger-balance commercial real estate loans will have different—and typically more stringent—penalty structures, and even “lockout” periods where prepayment is totally prohibited. Also, some states have restrictions or bans on prepayment penalties offered on DSCR loans at all.

 

Seasoning

 

This term has nothing to do with making dinner—it refers to the amount of time the property is owned by an investor. It is typically used in the context of when a property is eligible with a particular lender to be refinanced and usually expressed in months. Many lenders will have minimum seasoning requirements before doing cash-out refinances, with banks and conventional lenders being more conservative and typically having longer seasoning requirements than private lenders that specialize in DSCR loans.

 

 

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Robin Simon
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