DSCR loan (Debt service coverage ratio) is also referred to as investor loans, or rental loans and belongs to the non-QM loan category.
You can obtain a conventional loan for real estate investment, but this financing is more complicated to qualify for and has substantial liquid reserve requirements. DSCR Loan, on the other hand, is specifically designed for real estate investors.
Who are the candidates for the DSCR loan?
The DSCR loan is a good choice for investors who do not want to provide employment information, tax returns, pay stubs, W2s, etc. It’s ideal for self-employed borrowers with very complex incomes looking for an investment property and it’s very hard to be qualified for a conventional loan.
It’s good for a real estate investor who wants to buy or refinance an investment property but does not have enough personal income to be accepted or does not want to provide their tax, financial, and job paperwork, who will be a good candidate for the DSCR loan program.
It’s ideal for investors who want to protect their personal assets and apply under LLC or entity name.
It can also be a great option if you own several investment properties and have already reached the limit of 10 conventional loans.
General requirements:
- 640+ FICO (some lender requests 700+ FICO)
- Up to 75% – 80% LTV (generally require min. 20% down payment)
- First-time investors: Up to 75% LTV
- Investment properties only
- Loan amounts up to $1.5M-$2M (some lender offers more)
- Minimum debt service coverage ratio 1.0 (ideal 1.25 +)
- Cash-out can be used to meet reserve requirements
- Properties can be in LLC’s name
- No limit on the total number of properties
What is a DSCR loan?
In DSCR loan programs, the lenders use the cash flow (rent) generated by the subject investment property instead of traditional income proof, tax returns, employment, etc.
It doesn’t involve personal income analysis; only focuses on the rental property you are about to purchase.
DSCR loans usually require an appraisal with a rental survey. The rental survey tells the lender how much rent is to be expected based on rental comparables. If the loan amount exceeds certain limits, a second appraisal might be required. The borrower is in charge of the appraisal fees.
How to Calculate DSCR (Debt service coverage ratio)?
DSCR is the ratio of Net Operating Income (NOI) to Debt Service (the mortgage payments).
Net Operating Income (NOI) is calculated by subtracting all operating expenses from the property’s gross income. This includes things like taxes, insurance, and repairs.
Debt Service, current debt obligation, such as principal, interest, taxes, and insurance,
As an example, the borrower has an investment property in mind that has a monthly lease income of $6,500 and a monthly PITI debt of $5,200. The DSCR in this example is 1.25. the property generates 25% more income. This also means a positive cash flow in the lender’s eye.
This valuation provides the lender with a quick tool to break down the borrower’s ability to sustain and pay off the debt obligation on a real estate investment.
What is a Good DSCR Ratio?
Most lenders demand that their clients have a DSCR ratio greater than 1.00. The average minimum for most lenders is 1.25.
Of course, the higher the better. Because a DSCR ratio of 1.00 indicates that the borrower will have adequate cash flow from the subject property to pay off the loan.
If the DSCR ratio is 1.25, the borrower can make loan payments and have some extra. A DSCR ratio of 1.50 would provide even more breathing room for the borrower.
What are the advantages of a DSCR Loan?
- Faster application and closure times: you don’t need to submit any personal financial information or job history.
- You can commit to many properties simultaneously: Some mortgages only allow you to commit to only one home at a time, and you can’t get a loan for a second property unless you’ve paid off your previous one. DSCR loans allow you to obtain many loans for different properties at the same time simultaneously.
- Unlimited Cash-Out: you can take out as much cash as you need when you need it. This is a good option for unexpected expenses to cover.
- Ideal for both first-time and experienced real estate investors. If you’re new to investing, this loan can help you get started on the right foot. And if you’re an experienced investor, a DSCR loan can take your business to the next level.
- Closed in LLC or entity: Experienced investors prefer to borrow through an LLC or corporation to protect their identity and other investments. This adds an extra layer of protection to the investor’s personal assets for any unfortunate incidents on the property. Conventional loans can only be obtained in an individual(s) name.
- No leases are required to be listed. No lease required if not rented
The downside of a DSCR loan
Like other non-QM loans, DSCR loans’ interest rate is higher than conventional loans, so make sure you shop around a few lenders to compare their rates, fees, and other requirements.
Here are some considerations who you compare DSCR loans from different lenders:
- Lender rate and fees: It is important to know exactly what your costs will be for the loan. The last thing you want is to end up at the closing table with unexpected costs
- Lenders eligible property types: Find out if the subject property fits the lender’s requirement. Some lenders have DSCR Loan Programs for vacation rentals and others do not. Other common variations include warrantable vs. non-warrantable condos and multi-family vs. single-family homes. Short-term rentals and VRBOs are ok but no condotels or hotels.
- Property insurance requirements, because they typically are materially different for investment properties as compared to owner-occupied properties
- Prepayment penalty or rate buy-down options. DSCR loans almost always have a prepayment penalty.
DSCR loan program is a good alternative loan program for real estate investments. Whether you’re just starting or you’re a seasoned real estate investor, a DSCR loan is a smart option, and it takes you to the next level of real estate investment.
