It is no secret that when choosing an investment strategy, you need to consider many factors – risk tolerance, personal goals, diversification, and so on. Especially important to consider is the current state of the economy coupled with where it is headed, because private lending is heavily dependent on market economics.
Take rising interest rates. Though lending on real estate generally has the potential for positive returns over time due to inflating property values, private lenders need to carefully consider the effect on their borrowers, who are less likely to borrow or may be more cautious in a high interest rate environment. This goes for all types of loans, including long-term rental/DSCR and bridge.
2022: The Year of Rising Interest Rates
Mortgage interest rates dropped significantly during the COVID-19 pandemic and remained low through 2021, sending demand for properties through the roof. 2022, however, is a different story. Interest rates have increased sharply compared to previous years; the average rate for a 30-year fixed mortgage reached 3.5% at the end of January.
In early May 2022, to combat a 40-year high in inflation and attempt to restore price stability, the Federal Reserve raised its benchmark interest rate by half a percentage point. This hike pushes the federal funds rate to 0.75%-1%, and, according to CME Group data, current market pricing has the rate rising to 2.75%-3% by year’s end.
Impact on Lending
Until inflation slows, which very well could drag into 2023, lenders should be prepared to budget for continued increasing interest rates. What does this mean for different loan types?
Long term rental loans, or DSCR (debt service coverage ratio) loans, have become popular in recent years for lenders looking to buy and hold properties. Borrowers love them because these loan types allow them to qualify for a home loan using their property’s cash flow rather than their income, and lenders/investors love them because they can help expand their investment portfolio.
Due to rapidly rising interest rates, however, property mortgage debt is increasing as well, making it more difficult to meet the minimum DSCR requirements for borrowers. Because of this, we expect to see DSCR loans decline in popularity until interest rates even out again. In place of DSCR, we expect to see lenders falling back to bridge lending with more competitive rates.
If you jumped into the private lending arena while DSCR loans were a hot commodity or are wondering how to transition your business to focus back on short term bridge loans, our team of experts is here to help. Our attorneys have wide knowledge with various loan products and know the pros, cons, and business strategies associated with each. We would love to assist you with your lending strategy and help you pivot to a new product to continue growth.