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The prior two sections walked through the key factors influencing DSCR loan terms, credit score (FICO), Loan-to-Value (LTV), and Debt Service Coverage Ratio (DSCR), along with additional pricing considerations such as property type, loan purpose, prepayment penalties, amortization structure, and rate structure.
Now let’s dive much deeper. This section will walk step-by-step through exactly how DSCR Lenders generate quote options and loan terms, revealing the precise methods and calculations lenders use to arrive at the specific rates and fees offered.
This is a blueprint on exactly how lenders price loans behind the scenes, how they adjust base interest rates using matrices, Loan-Level Price Adjustments (LLPAs), and premium pricing models. We’ll include clear mini-charts, visuals, and detailed examples to make every concept intuitive. A true “peek behind the curtain” to see how the proverbial DSCR Loan sausage is made.
The very first step a DSCR Lender takes when generating loan terms is consulting what's known as their interest rate "stack." This stack is simply a vertically listed series of interest rates, typically presented in increments of 0.125% (or 12.5 basis points, also sometimes referred to as an “eighth” or 1/8 of a percent), each paired directly with a corresponding premium number (also known as the price premium).
Before diving into how lenders adjust rates based on each potential loan scenario or application, it’s critical to clearly understand exactly how lenders create these base interest rate stacks from current market interest rates and what these premium numbers actually mean.
Every DSCR Lender's rate stack starts with a foundational market-based interest rate, also referred to as a par market rate. This “par” rate corresponds exactly to a premium price of 100. In other words, at the par rate, the loan sells precisely at its face value, no additional premium and no discount. If the lender sets an interest rate above this par rate, the loan sells at a premium (greater than 100); if the rate is below the par rate, it sells at a discount (below 100).
This par market rate is not random; it's derived directly from current market conditions. Generally, it comes from adding the 1) US Treasury Yields (“Risk-Free” Rate) (Typically, the 5-year or 10-year US Treasury yield, as these maturities align closely with DSCR Loans) and 2) Mortgage Risk Premium (Spread) an amount to compensate lenders (and note buyers) for the additional risk of investing in DSCR Loans versus investing in government bonds. Treasuries are considered “risk-free” benchmarks because they're backed by the U.S. government’s full faith and credit. When combined, these two elements form the DSCR Lender’s base “par” interest rate.
For example, if the current 10-year Treasury yield is 4.50% and the required mortgage risk premium is 2.625%, the lender’s “par” DSCR interest rate would be 7.125%. At this exact rate, the premium is exactly 100, meaning no additional premium or discount.
DSCR Lenders create their interest rate stack by listing multiple interest rates around this par rate, each corresponding to a specific premium price.
Note: The difference in premium for each change (of 0.125%) in interest rate is not always linear or a one-for-one change. In our sample, each change in interest rate changes the premium by twice as much (i.e. an increase in 0.25 in premium for every 0.125 increment in rate) for most of the rate stack, however it’s four times as much at the lowest rate portions (i.e. an increase in 0.50 in premium for every 0.125 increment in rate), or in our example, when rates are between 6.500% and 7.000%. This is fairly common among lenders and another reason why saying how one thing or another (such as increasing your credit by XX points or lowering your LTV by Y percent) doesn’t always have an easy or consistent answer, since it could move your premium by different amounts or magnitudes depending on all the specific loan factors.
DSCR Lenders earn most of their revenue from DSCR Loans by combining two separate but interconnected sources:
The combined total of these two income sources is typically targeted by DSCR Lenders to reach a specific gross profit margin, often expressed as a number slightly above 100, such as 102 or 103. In plain English, a "102" means the lender earns a gross profit margin of 2%, while a "103" corresponds to a total gross profit margin of 3%.
Note, that this is a gross margin the lender stands to make on each loan and doesn’t take into account all of the costs associated with it; including commissions to loan officers or account executives or referral fees to mortgage brokers or referral partners. It also doesn’t include typical lender operating expenses such as rent, labor costs for the operations team, software licenses and more. While the DSCR Lender shoots to make a two or three percent gross profit margin on every loan, the actual amount that is profit is usually significantly lower, so there is likely not much room for negotiation on pricing.
Crucially, many DSCR Lenders are flexible (i.e. "agnostic") to exactly how this total is reached. Many DSCR Lenders would, for example, consider all the following examples equally profitable:
All scenarios are exactly equally profitable to the DSCR Lender. This gives investors substantial flexibility to pick the rate-and-fee combination best aligned with their personal financial goals, whether minimizing upfront costs, reducing long-term payments, or balancing both.
While the best DSCR Lenders may offer maximum flexibility between how each individual investor would like to balance rate and closing fee, all DSCR Lenders will have a minimum rate (“floor rate”) and usually a maximum rate as well, where no matter the margin math, those will be the lowest and highest rates allowed (6.500% and 8.500% respectively in our example rate stack above).
That covers the “starting point” for the DSCR Loans pricing process, with the base stack (derived from market rates built from Treasury “risk-free” yields and a “spread” for the riskier nature of mortgage loans) and the lender’s profit margin (built from a combination of closing fee and loan sale premium) the key factors. But not all DSCR Loans have the same pricing (rates and fees), there are obviously different terms offered not only based on the balance between closing fee and sale premium.
Rates and terms differ for each DSCR Loan, and these differences are derived through risk metrics (such as FICO, LTV, DSCR, Property Type, etc.) and loan structure provisions (such as Prepayment Penalties, Fully Amortizing vs. Partial-IO, Fixed Rate vs. Hybrid (Fixed to ARM), etc.). The next step in the pricing process is how DSCR Lenders make specific, quantitatively measured pricing adjustments based on each individual DSCR Loan’s risk metrics and loan structure. These adjustments are referred to in the industry as LLPAs, or “Loan-Level Price Adjustments,” which, when combined with the base stacks and balance between upfront fees and premiums, produces the full set of DSCR Loan terms offered.
Up Next: In "Step 2" of the Full Example of How DSCR Lenders Generate Your Rate & Terms, see exactly how the Loan-Level Price Adjustments (LLPAs) are applied!
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