What Are the Options, and How Do DSCR Loans Stack Up?

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The BRRRR method of real estate investing continues to be one of the most-used strategies in 2023. With interest rates elevated yet property values remaining resilient, finding cash flow with a reasonable down payment is an incredible challenge.  

However, the BRRRR strategy (buy, rehab, rent, refinance, repeat) makes sense for a lot of investors, as value can be created through forced appreciation (renovations) and capital recycled through cash-out refinances. With rates high and competition fierce, nailing the financing piece of the BRRRR method has never been more important.  

This article will explore the loan options facing BRRRR strategy investors, with a focus on the all-important third R: refinance. Specifically, we’ll compare DSCR refinance loans to traditional options, namely bank or conventional loans.

The Evolution of Options

With the publication of Buy, Rehab, Rent, Refinance, Repeat: The BRRRR Rental Property Investment Strategy Made Simple by David Greene in 2019, the BRRRR method was publicized to real estate investors, and real estate investing was never the same. In the book, each step of the BRRRR method is meticulously explained, and it’s jam-packed with advice, tips, and information, including two chapters all about the crucial refinance portion of the process.

In the book, Greene details all the different options for refinancing, along with the pros, cons, and details of each. However, DSCR loans are not mentioned.

Why? While DSCR loans existed back in 2019, the product was just getting started and not widely developed or available. A lot can change in just four years (as everyone on the planet who lived through 2019-2023 knows).  

Five years ago, BRRRR method investors were generally limited to conventional loans (under government-sponsored enterprise, or GSE, rules and limits), bank portfolio lenders, or other niche options like private money (individuals). While these options still remain solid options for many investors, the growth and development of DSCR loans has truly changed the landscape for BRRRR strategy real estate investors.

Beginning BRRRR: Buy in Cash, or Use Hard Money?

While refinancing is an important part of BRRRR and can make or break many BRRRR method deals, the first two steps, namely buying and rehabbing, are vital to success. Finding deals is one of the most important skills a real estate investor can have, but it’s not always enough. Finding a deal and closing a deal are two different things—making sure you can move fast and execute a close (and beat out potential competitors) is a prerequisite to a successful BRRRR (if someone else is able to purchase the property, your BRRRR investment is dead).

Many BRRRR method investors make property purchases in cash, whether due to not being aware of other options (using a hard money loan) or thinking it’s better financially. In the BRRRR book, Greene generally limits the BRRRR strategy to cash purchases, but hard money loans, or loans that are generally short-term and higher-rate, have also evolved a lot over the last four years.  

For one, while the hard money terms example used in the book is 14% interest rates and four origination points, many hard money loans today will have fees that are half of that and significantly lower interest rates. Additionally, the internet continues to democratize access to information, and hard money lenders can be vetted and compared much more efficiently online, such as here on BiggerPockets.

Advantages of using cash for BRRRR

What are some advantages of using cash to purchase and fund renovations for BRRRR projects?

• Lower interest cost: Simply, funding your purchases and renovations yourself saves you interest expense—typically a few months’ worth.
• More competitive offers: Many sellers prefer cash offers over ones with financing because there is more certainty of closing (financing will typically require lender diligence periods, which causes time, such as waiting for an appraiser to visit the property and produce a report, as well as risks of falling through—that same appraiser finding an issue, etc.).
• Less risk: Without interest or looming maturity dates, investors are less stressed if rehabs or the renting process are delayed.

Advantages of using hard money loans for BRRRR

However, with these advantages, there are many benefits of using hard money loans to finance the first two steps of the BRRRR method that outweigh the cons for many real estate investors. These include:

• Get started faster: Let’s face it—while reading articles like this and absorbing all the podcasts and books on real estate investing is great, jumping in and actually doing your first deal is critical, and what you learn from experience often dwarfs knowledge from all the research sources by far. By buying and rehabbing with only cash, that means saving up all the funds needed for both—often a minimum of $75,000 to $100,000 at current market prices. Most people, let alone real estate investing beginners, don’t have that kind of money lying around and can only get started on the financial freedom journey by getting a good chunk of these costs financed by a hard money lender (typically up to 85% or 90% for beginners).
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• Faster portfolio growth: A key advantage of the BRRRR method is to use the smallest amount of capital to build a portfolio as fast as possible. With the power of compounding, doing three deals at a time versus one at a time can mean the difference of hundreds of properties in a portfolio. As such, an investor funding a $120,000 BRRRR buy and rehab in all cash grows the portfolio much slower than an investor who executes three $120,000 projects with $40,000 invested in each (with hard money financing of the remaining $80,000).
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• Higher leverage on the refinance: Believe it or not, a BRRRR method investor who refinances a hard money loan is looked at more favorably by a lender than someone who bought in all cash. While this may not seem logical, many lenders will give more favorable terms to what is called a rate-term refinance versus a cash-out refinance, the difference typically defined as whether you take home greater than $2,000 at closing of the refinance loan (cash-out) or not (rate-term). Many lenders have seasoning, loan amount, and LTV restrictions that are applied to BRRRR method investors only on cash-out refinances, and these don’t apply if it’s a rate-term refinance.

Additionally, some hard money lenders don’t require appraisals for the purchase of a BRRRR property. This allows a BRRRR method investor to be competitive with cash offers and eliminates one of cash buyers’ main advantages.

Refinancing: Conventional or Portfolio Lenders vs. DSCR

There are multiple considerations to optimize the refinancing portion of the BRRRR method. Generally, for the optimal refinance, these are top of mind for BRRRR strategy investors:

• Return of capital: The key “secret sauce” of the BRRRR method is to build portfolios using the same capital over and over—which relies on getting your basis (or more) back on the refinance, where basis refers to the money you invested in the property (down payment and cash used for renovations).
• Speed: Refinance lenders use the term “seasoning” to refer to the amount of time (typically in months) between the purchase of the property and the refinance. Velocity of money, or speed in which you can complete a BRRRR investment and repeat, is key to success, and refinancing with the shortest seasoning requirements is highly important.
• Loan terms and interest: Cash flow is also an important consideration for a refinanced rental property, so attaining a low interest rate, as well as other aspects of loan structure (term, amortization, or interest only, etc.), plays a big role.

Generally, there are three main refinance options for BRRRR method investors: 

• Conventional loans
• Bank/credit union loans
• DSCR loans

Conventional loans are generally defined as loans originated under GSE (Fannie Mae/Freddie Mac) rules and guidelines and securitized. Bank and credit union loans are generally defined as “portfolio lenders,” or lenders that hold the loans on their balance sheets. DSCR loans are loans issued by private lenders with proprietary and differentiated rules and guidelines and are typically included in “non-QM” securitizations.

The advantage of conventional refinance loans is that they typically have the lowest interest rates and fees. However, BRRRR method investors have run into a lot of trouble using conventional loans for refinances for multiple reasons, especially in 2023.  

One issue is the challenge of qualifying, as conventional loans will have DTI requirements, income requirements, loan size limits, and loan amount limits that investors looking to scale a portfolio run into as soon as the financial freedom snowball starts rolling. But most importantly, in April 2023, Fannie Mae changed cash-out refinance seasoning requirements from six months to a full year. This is hugely problematic for the “speed” aspect of BRRRR investing—drastically slowing down the returns and velocity of capital for BRRRR investors using conventional loans.

Portfolio lenders are another option, and they typically offer competitive rates and fees as well. Banks and credit unions can also offer flexibility for investors that engage in strong relationship-building strategies, offering discounts and solid loans in exchange for borrowers willing to use the institution for other purposes (savings accounts, etc.). However, downsides include regulatory restrictions on bank lending, many institutions that restrict concentration and geographies, and other headaches and issues that arise when dealing with a slower-moving bank.

DSCR loans are the option that has completely changed the BRRRR lending landscape in the last few years. While DSCR loans tend to have interest rates a bit higher (generally 0.75% to 1%) than the other two options, which can challenge cash flow, this comes with some advantages that are uniquely suited to the BRRRR method. These advantages of using DSCR loans for refinances using the BRRRR method include:

• More flexible seasoning requirements: As of April 2023, the seasoning requirements for conventional cash-out refinances is now 12 months, but many DSCR lenders are still at just six months (with some even as little as three). Additionally, for rate-term refinances, many DSCR lenders have no seasoning requirements at all.
• Easier qualification: DSCR lenders have much lighter qualification requirements than conventional or portfolio lenders, such as no DTI, income verification, or tax return hurdles that can slow down or disqualify loans
• Flexibility: While conventional and bank lenders are heavily regulated and follow standardized rules, DSCR lenders have much more flexibility and control over their guidelines. This allows DSCR loans to be more adaptable to the market as real estate investing strategies change, including the BRRRR method. Some examples of this include being able to embrace the “AirBnBRRRR” strategy (i.e., not requiring a long-term lease for the “rent” portion of BRRRR before approving the refinance) or allowing investors to borrow in an LLC or other creative structures.

Hopefully, this article helps BRRRR investors navigate the market in 2023, knowing all the financing options available for success.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.