Your Next Best Investment Solution: The Pros and Cons of Interest-Only DSCR Loans

Interest-only DSCR loans can be a valuable option for real estate investors because they reduce the initial payment amount for a set period.

During this period, which can range from a few months to several years depending on the lender, the borrower does not have to make principal payments.

After the interest-only period is over the borrower will have to repay this amount, but by this point, they should have secured the financing required to cover the principal and interest payments.

To determine if this is the right option for your unique lending scenario, let’s explore the pros and cons of interest-only DSCR loans.

What is a DSCR loan?

A debt service coverage ratio loan, or DSCR loan, is among the most popular loan options for investors in today’s market because it evaluates a borrower’s ability to repay based on the property’s income.

Unlike a conventional mortgage, which relies heavily on a borrower’s income, employment, credit, and debt, the primary focus of a DSCR loan is on the income-generating capacity of the asset.

This means that borrowers with a strong cash flow from their investment may qualify even if they are less-than-perfect in other aspects.

DSCR is calculated using the following formula:

DSCR = Net Operating Income (NOI) / Total Debt Service

A DSCR greater than 1 indicates that the property generates enough income to cover its debt obligations.

For example, a DSCR of 1.2 means that the business has 20% more income than required to cover its debt.

Park Place Finance offers investors maximum flexibility by allowing a DSCR as low as 0.75.

How does an interest-only DSCR loan work?

An interest-only DSCR loan is a type of loan where the borrower is only required to make interest payments for a specified period, typically at the beginning of the loan term.

During this period, the borrower is not required to make payments toward the principal amount of the loan. Instead, they only pay the interest accrued on the outstanding balance.

The interest-only period is predetermined and agreed upon between the borrower and the lender. Common durations for the interest-only period range from a few months to several years.

One of the main benefits of interest-only DSCR loans is that they result in lower initial monthly payments compared to loans with both principal and interest payments.

This reduced financial burden during the interest-only period can be helpful for investors, especially those with tight budgets or those expecting future growth.

Pros of interest-only DSCR loans

Every loan product has pros and cons depending on the unique needs of the borrower.

Here are the greatest benefits of an interest-only DSCR loan for the right borrower.

Increased cash flow

By paying only the interest, investors will have an increase in short-term cash flow.

This additional cash can be used to cover operational expenses, make strategic investments, or address pressing financial needs.

Greater financial flexibility

The reduced payment obligations during the interest-only period offer greater financial flexibility.

Borrowers can adapt their financial strategies based on current market conditions or portfolio needs without the pressure of higher monthly payments.

Easier entry for investors

Interest-only periods can make it easier for investors to enter the market, especially when purchasing income-generating properties.

Lower initial payments reduce the financial burden, making the investment more accessible.

Potential for higher returns

Investors may use the additional capital from lower monthly payments to reinvest in other opportunities, potentially leading to higher returns on investment.

Cons of interest-only DSCR loans

Interest-only DSCR loans are not suitable for every borrower.

Let’s explore the potential drawbacks of interest-only loans to help you determine whether it’s a smart financial decision for you at this time.

Monthly payments will increase

When the interest-only period ends and the loan transitions to full amortization — including both principal and interest payments — borrowers may experience a significant increase in monthly payments.

These increases can strain an investor’s cash flow and financial stability.

Higher long-term costs

While the initial payments are lower during the interest-only period, you may be left with higher overall costs over the life of the loan.

This is because you are not reducing the principal balance during the interest-only period.

You’re not building up equity

Since the borrower is not paying down the principal during the interest-only period, there is limited equity being built up in the property.

The limited equity can affect the long-term financial stability of the property, especially if the value of the property declines.

Which types of borrowers should get an interest-only DSCR loan?

Investors targeting non-owner-occupied residential properties, such as single-family or multi-family properties, may find an interest-only DSCR loan beneficial for maximizing their returns short term.

Interest-only DSCR loans also are helpful in markets where property values are expected to rise, or for investors who are experiencing temporary cash flow challenges.

Investors must determine whether the potential risks outweigh the benefits for their unique investment scenario, including evaluating whether they can afford the increase in payments once the interest-only period ends.

Working closely with a trusted, experienced hard money lender will help investors find the most suitable financing option for their specific needs.

Apply for a DSCR loan from Park Place Finance

At Park Place Finance, we pride ourselves on providing you with a personalized and efficient lending experience.

We are a direct hard money lender with in-house capital and over $1 billion in loans funded.

Our DSCR loans are designed for various rental properties to meet your investment real estate needs, including:

• Single-family homes
• Duplexes, triplexes, quadplexes
• Warrantable condos
• 2-50 property portfolios
• Urban properties within 42 states

You’ll love the ease of closing with Park Place Finance because of our common-sense underwriting.

Get started today by filling out our simple online form, or calling us at (866) 407-1599.