In order to achieve lower default rates on single-family rental investor loans, many single-family rental originators have enhanced their underwriting criteria and are now qualifying borrowers for SFR investor loans based on property income rather than personal income, according to research from Morningstar Credit Ratings.
The traditional way to underwrite single-family, single-property investor loans has been to do them as residential instead of commercial loans. Borrowers typically include information on projected rental income from the property and add a portion of this to their personal income; however, lenders of residential investor loans commonly qualify borrowers for loans based on the borrower’s personal income and credit instead of whether or not the projected rental income from the property can cover the debt service.
One of the main factors that prompted lenders to start focusing on property income when considering approval for a residential investor loan is the lower default rates on properties where the income from the rent more than covers the debt. Research from Morningstar found lower-than-average default rates among investor loans where the property income is greater than 1.2 times the debt service.
“This approach makes sense: borrowers should be less likely to default if a property generates enough rent to cover debt obligations and are more likely to default if the debt service exceeds the rent,” wrote Morningstar Credit Ratings RMBS Managing Directors Brian Grow and Becky Cao. “It is common practice for commercial lenders to look at debt service coverage ratios as a key driver of default, and it seems logical to apply this approach to single-property investor loans.”
Morningstar examined approximately 900,000 nonagency investor property loans originated from 2002 to 2007 in order to determine the how debt service coverage affects default rates (using regional rent estimates from RentRange to individual investor properties in the CoreLogic In. nonagency loan-level data).
“The results showed significantly lower defaults for investor loans with rents exceeding debt service payments and higher defaults for similar loans with rents that do not cover debt obligations,” Grow and Cao wrote.