August 19, 2024 | 2 Minute Read
Back in April, I discussed the 1% rule and its relevance to real estate investing. The 1% rule helps investors evaluate a property’s price against its potential gross income. According to this rule, the monthly rent should be at least 1% of the purchase price. For more details, see “1% rule in real estate investing explained.”
With interest rates above 7%, the 1% rule becomes challenging to apply unless your loan-to-value (LTV) ratio is lower, meaning you’ll need to contribute more cash upfront. Instead of an 80% loan with a 20% down payment, you might need to put down 30% to achieve a 70% LTV. Additionally, the debt service coverage ratio (DSCR) should be at least 1.2. We previously discussed the DSCR in “What is a DSCR Loan?“
Here’s an example with a 7.5% interest rate, cash flow and DSCR:
- Purchase price: $100,000
- Loan amount: $80,000
- Monthly rent: $1,000
- Monthly taxes and insurance: $200
- Monthly PITI (Principal, Interest, Taxes, Insurance): $759.37
- Estimated monthly cash flow: $240.63
- DSCR: 1.11
Although the property cash flows, the DSCR of 1.11 falls short of the required 1.2. As a result, the lender will reduce the LTV from 80% to 74% to achieve the minimum DSCR, requiring you to increase your down payment to 26%, as the lender would finance only 74% of the total loan amount.
Recently, there’s been speculation that the Federal Reserve might cut interest rates by half a percentage point at its September 17-18 meeting, due to weaker-than-expected labor market data. Currently, there’s a 75% probability of a quarter-percentage-point cut next month.
The U.S. Labor Department recently reported that the annual increase in the consumer price index slowed in July to below 3% for the first time in nearly three and a half years. Additionally, a modest rise in producer prices last month indicated that inflation is steadily declining. Meanwhile, weekly jobless claims fell to a one-month low, and retail sales surged in July, highlighting the continued strength of consumer spending.
With all these factors aligning, a rate cut seems likely, and commercial lenders have started to adjust their rates accordingly. We’re now seeing rates as low as 6.75% for purchase and refinance loans.
At a 6.75% interest rate, the $100,000 property purchase becomes more attractive:
- Purchase price: $100,000
- Loan amount: $79,500
- Monthly rent: $1,000
- Monthly taxes and insurance: $200
- Monthly PITI: $715.65
- Estimated monthly cash flow: $284.36
- DSCR: 1.2
To achieve the required 1.2 DSCR, the loan is adjusted to a 79.5% LTV. If rates drop further to 6.7%, the 80% purchase loan amount would meet all underwriting requirements.
These rate drops are encouraging for investors using the BRRRR strategy and those waiting to refinance their rental properties. At 6.75%, the rate is even more attractive for a 75% LTV cash-out refinance. With a $100,000 ARV and 75% LTV, your monthly net would be $313.55 with a 1.27 DSCR.
For those looking to purchase or refinance, please visit our sponsor – REIBrokers