If you’ve been in the real estate investment game for a while, you might have your eye on a promising new property but lack the funds for the down payment and other upfront costs. In this circumstance, you can leverage your existing properties in order to finance your new investment through a DSCR cash-out refinance; this allows you to draw equity out of your existing properties through a lump sum, which is perfect for down payments or renovations.
Whether you have a DSCR loan in Kansas or anywhere else, here’s what you need to know about DSCR cash-out refinances, including their benefits and some cautions about using this powerful investment tool.
What Is a DSCR Loan?
First, let’s discuss what a Debt Service Coverage Ratio (DSCR) loan is so that you can understand how a refinance will work. Instead of relying on your personal finances to ascertain whether you qualify, a DSCR loan is based on the ratio of your property’s income to its debts. Your rents are divided by the mortgage, taxes, insurance, and association dues to develop a number that identifies whether it is making a profit. Typically, DSCR lenders want a ratio of 1.25 or more.
If you have had your property for a while and shown excellent investment responsibility, your ratio will naturally go up because you are spending less to service the debt; you’ll also have more equity built up, which you can pull out with a refinance.
Why Should You Consider a DSCR Refinance?
DSCR cash-out refinances are incredibly beneficial for investors because they are easy to qualify for, ensuring a quick turnaround for your application. Just as with any other mortgage, you can refinance them in order to access your equity for your next investment, but you won’t need to jump through a variety of hoops about your creditworthiness: DSCR loans are primarily concerned with the value of the property rather than your personal finances.
What Happens With a DSCR Cash-Out Refinance?
When you choose to get a cash-out refinance with a DSCR loan, the lender will identify the Debt Service Coverage Ratio to determine whether you qualify. The property is then appraised to identify how much equity is built up, and you will take out a new DSCR loan to cover the remaining costs of your original mortgage. The difference between how much you still owe on the original mortgage and how much your property is worth will be given to you in a lump sum, which you can then use to pay for a new property or renovate your existing holdings.
Can You Use a DSCR Cash-Out Refinance If Your Previous Loan Was Not a DSCR Loan?
Yes, absolutely. It’s common for investors to use a conventional mortgage to buy their first few properties and then refinance into a DSCR loan once their original property has built up enough equity to make it worthwhile.
When you refinance a mortgage, you are paying off and closing out the original one; usually, the type of loan and the lender does not matter, as you can refinance with a different lender if you so choose. For a DSCR refinance, what matters is that your property qualifies for any type of DSCR loan: it has to have a Debt Service Coverage Ratio that satisfies the lender’s requirements. If you have had your property for a while, are still generating money from it, and have paid off a significant portion of your mortgage, then you are very likely to qualify for a DSCR cash-out refinance.
When Should You Not Use a DSCR Cash-Out Refinance?
Like with other cash-out refinances, you should only use this option if you have built up significant equity; otherwise, the money may not be worth the hassle. You can always refinance into a DSCR loan without leveraging your equity if you choose, but you would simply get a rate adjustment rather than a lump sum.
If you already had a DSCR loan and are trying to access the equity now, avoid refinancing in the first five years, as you will have to face a prepayment penalty. DSCR loans are unique in that if you pay ahead of time within that period, you will have to pay a percentage of the principal in addition to your payment. This stands true even if you are doing a cash-out refinance, as you are technically paying off and closing out the original loan.
Overall, DSCR loan cash-out refinancing options are an excellent way to boost your business by covering down payments on new properties or improving your existing buildings so that you can raise rents. They are simple, straightforward, and can be used by an investor even if they did not originally purchase their property using a DSCR mortgage. However, be aware of the prepayment penalty within the first five years so you don’t find yourself getting a smaller payout than you expected.