In this article, I’m going to teach you everything that you need to know about DSCR loans and how they can help you purchase investment properties. This somewhat “little-known” loan can be the tool you need to kick off your real estate investment career or help you increase the size of your real estate portfolio rapidly.
Let’s dive in.
What are DSCR loans?
Let’s make this simple.
DSCR loans are a type of mortgage financing used in investment real estate including residential, commercial and even industrial. DSCR stands for debt service coverage ratio and it’s a way to measure the cash flow of an investment property.
DSCR loans are just mortgages that use this ratio as a factor in determining loan eligibility and terms.
How to calculate the DSCR of an investment property?
The best and easiest way to calculate the debt service coverage ratio for a DSCR loan is by dividing the rental income of the property by the monthly house payment. This payment will include the principal and interest, taxes, insurance and HOA if applicable. The result is a number that shows how many times over the income will cover the property’s payment.
For example, if the expected rent of a property is $3,000/month and the payment is $3,000/month, the ratio is 1. If the rental income is $3,000/month and the payment is $2,500/month, the DSCR would be 1.2.
In general, most mortgage lenders require a minimum DSCR of 1, sometimes even less, to consider lending on an investment property.
At Andes Mortgage, we have DSCR loans were the ratio can be as low as 0.75 and sometimes, even no ratio is required. But remember, most lenders will want to see that the property’s income can at least cover the payment.
How DSCR is Calculated
The DSCR is calculated by dividing the net operating income (NOI) by the total debt service. The formula is:
DSCR= Rental Income / Property’s Payment
For example, if a property generates $3,000 a month in rents and the payment is $2,500 a month, the DSCR would be 1.2.
Why DSCR Matters
The DSCR is crucial because it indicates the financial health of a property or business. Lenders use this ratio to determine the risk of default.
A higher DSCR suggests that the borrower is more likely to meet their debt obligations, while a lower DSCR indicates higher risk.
With that being said, the higher your DSCR ratio is, the lower your interest rate will be. Likewise, if your DSCR is low or under 1, you should expect higher interest rates.
Differences between a DSCR loan vs a Conventional Mortgage
At this point, you’re probably wondering why this loan over a more commonly known loan such as a conventional mortgage.
Unlike traditional mortgages, where your personal income is required, DSCR loans only take into consideration the income that the investment property generates.
This is huge for investors, self-employed borrowers, or even salaried borrowers who want to acquire multiple properties in a real estate portfolio. With conventional mortgages, it becomes increasingly more difficult to qualify when multiple properties come into play, and personal income can’t cover the mortgage payments.
Since DSCR loans don’t look at your personal income to qualify, you can purchase as many properties as you wish, so as long as you meet the minimum down payment and credit requirements and like we said before, the DSCR ratio is sufficient for the lender.
The Advantages of DSCR Loans
Flexibility: Traditional mortgages can be restrictive in terms of how many properties you can acquire because of the need to show personal income. DSCR loans offer greater flexibility as they focus on the investment property’s income rather than the borrower’s personal income.
Easier Approval Process: Since these loans do not require a borrower’s personal income, the approval process is usually quicker and less stringent than traditional mortgages.
Higher Loan Amounts: With conventional mortgages, lenders tend to limit how much they will lend based on a borrower’s debt-to-income ratio (DTI). With DSCR loans , lenders can extend credit into the millions of dollars.
Buying real estate properties under an LLC with DSCR Loans
Another significant advantage of DSCR loans is the ability to purchase properties under a limited liability company (LLC). This option offers several benefits, such as:
- Asset Protection: By purchasing properties under an LLC, your personal assets are protected from any potential liabilities that may arise from the property.
- Tax Benefits: LLCs offer tax advantages, including the ability to deduct expenses related to the investment property and avoid paying self-employment taxes.
- Easier Management: Operating under an LLC can make managing multiple properties more manageable, especially when it comes to bookkeeping and record keeping.
Blanket Loans with DSCR Loans
If you have multiple properties or are you looking to purchase multiple and want to wrap them under one loan, DSCR can be a solution.
With a DSCR loan, you can get a “blanket loans” or “portfolio loan”, which involve financing multiple properties on a single loan.
This type of loan offers several benefits:
- Simplified Financing: Instead of securing individual loans for each property, a blanket loan allows the borrower to manage and make payments on all properties under one loan.
- Lower Interest Rates: With a blanket loan, you may be able to negotiate lower interest rates compared to what you would get if you had multiple separate loans.
- Lower closing costs: Having one loan instead of multiple loans means fewer closing costs, saving you money in the long run. This can save you a lot especially if you are looking to refinance multiple properties and you are staring at tens of thousands in closing costs.
Qualifying for a DSCR Loan
To qualify for a DSCR loan, borrowers must meet certain criteria:
Credit score
To qualify for a DSCR loan, you’ll need a credit score of at least 640. However, the better terms, lowest down payments and better rates will be available to borrowers with credit scores at 740 or above.
Down payment
The minimum down payment for DSCR loans can vary from lender to lender but it can be as low as 15%. For most, you are looking at at least 20% down payment minimum. Again, for the better terms and rates, you’ll want to have a down payment of at least 25-30%.
Cash reserves
Lenders like to see that borrowers have enough cash reserves available to cover unexpected expenses or vacancy periods. This is usually 6 months worth of mortgage payments.
DSCR ratio
As mentioned earlier, the debt-service coverage ratio (DSCR) is a key factor in qualifying for a DSCR loan. Lenders typically look for a minimum ratio of 1, meaning the property’s income should at least cover the payment.
Prepayment Penalties
DSCR loans also carry prepayment penalties, meaning if you pay off the loan early, you may face additional fees. Typically, lenders will offer you different prepayment penalty timeframes ranging from 1 year up to 5 years. You are also able to waive the prepayment penalty but the lender will charge you higher fees for doing so.
Wrapping it all up
DSCR loans offer unique benefits for investors looking to finance rental properties or commercial real estate projects.
Qualifying is pretty easy from the personal standpoint but you have to do your due dilligence when it comes to evaluating a property’s cash flow. This will make or break your DSCR deal. However, this loan is definitely an attractive option for new and experienced investors.
At Andes Mortgage, we provide expert guidance and competitive rates for DSCR loans.
Contact us today to learn more about how we can help you finance your next investment property with a DSCR loan. Give us a call at 770-740-4050 to speak with a licensed mortgage professional submit an inquiry here.
