What if there was a home loan available that would allow you to increase your portfolio of rental properties without the limitations of regular mortgages?

Like, without having to show your tax returns, W2s, personal income. That kind of stuff.

Well, in fact, there is. And it’s a pretty great one in fact.

Enter, the DSCR Loan.

The DSCR loan is a type of real estate loan that is used to finance the purchase or renovation of income-producing properties. The acronym “DSCR” stands for Debt Service Coverage Ratio, and is a key metric used by lenders to determine a property’s ability to repay debt.

Here, we’ll explain what DSCR loans are, how they work, why they are becoming increasingly popular among real estate investors and if it’s the right fit for you.

HOW DO DSCR LOANS WORK?

The debt service coverage ratio (DSCR) is a popular metric used by lenders to determine a borrower’s ability to repay a loan.

The ratio is calculated by dividing a property’s net operating income (NOI) by its debt service, which is the annual principal and interest payments on the loan. A DSCR of 1.0 or higher indicates that a property generates enough income to cover its debt payments, while a DSCR below 1.0 indicates that it does not. 

For example, let’s say a property has an NOI of $100,000 and annual debt service of $80,000. The DSCR would be 1.25 ($100,000 / $80,000). This would be considered a strong DSCR, as the property generates 25% more income than is necessary to cover its debt payments. 

Let’s make it easier to understand.

You are looking at an investment property to add to your rental portfolio and you believe that you will be able to collect $3,000 per month in income.

Your monthly payment including property taxes and insurance comes out to $2,500/month. Utilizing the formula, $3,000/$2500 = 1.2.

Therefore, the property generates 20% more income than necessary to cover the debt and housing payments.

By comparison, a property with an NOI of $50,000 and annual debt service of $80,000 would have a DSCR of 0.625 ($50,000 / $80,000). This would be considered a weak DSCR, as the property generates only 62.5% of the income necessary to cover its debt payments. Properties with weak DSCRs are generally considered to be high-risk loans and may have difficulty qualifying for financing. 

Does this mean the DSCR is the only thing I need to qualify?

DSCR is an important metric for lenders because it provides insight into a borrower’s ability to repay a loan. However, it’s important to keep in mind that DSCR is only one factor that lenders consider when making lending decisions. Other factors include credit score, collateral value, and loan-to-value ratio (LTV).

In order for a loan to be approved, most lenders will require a DSCR of 1.0 or higher. This means that the property must generate enough income to cover at least the same amount as the debt service.

However, here at Andes Mortgage, we have DSCR loan options with a ratio as low as 0.00

WHY ARE DSCR LOANS BECOMING MORE POPULAR?

DSCR loans are becoming more popular for a number of reasons.

First, they provide borrowers with a fixed interest rate for the life of the loan, which can help to minimize interest rate risk.

Second, DSCR loans can help to minimize interest rate risk. This is because the loan is structured in such a way that the borrower’s DSCR must be sufficient to cover the loan payments. If interest rates rise, the borrower’s DSCR will also rise, which will help to ensure that the loan payments are always covered.

Third, DSCR loans can be used to finance a wide variety of income-producing properties, including office buildings, retail centers, apartments, and more. For residential real estate investors, this loan can be utilized for single family homes, condos, as well as small and large multifamily properties.

WHY ARE DSCR LOANS BECOMING MORE POPULAR AMONG INVESTORS?

For one, these loans are easier to obtain than a regular conventional mortgage.

Let’s face it, conventional loans can be a real pain to obtain, especially for real estate investors.

They require a slew of personal income documentation and in most cases, pristine credit in order to qualify. This is not counting with the fact that if the borrower’s personal income isn’t sufficient enough, qualifying is nearly impossible.

This is where DSCR comes in to play.

Since these loans are based on the property’s ability to generate income, it’s much easier for real estate investors to obtain financing. There’s no need for extensive personal documentation or perfect credit scores.

All that’s needed is evidence that the property can generate enough income to cover the loan payments.

For this reason, DSCR loans are becoming increasingly popular among commercial real estate investors.

GUIDELINES FOR GETTING A DSCR LOAN

There are a few guidelines that borrowers should be aware of before taking out a DSCR loan.

First, the loan amount must not exceed 80% of the property’s appraised value.

For instance, if an investor is thinking about purchasing a $500,000 property, the minimum down payment is $100,000 or 20%.

For a cash-out refinance, the maximum loan to value is 75%. Meaning that if the property is worth $500,000, the maximum loan that the investor can take would be no more than $375,000.

Second, the property must be income-producing, meaning that it must generate enough rent to cover the loan payments.

PROS AND CONS OF A DSCR LOAN

DSCR loans are often available with more flexible and sometimes, longer terms than traditional loans, giving borrowers more flexibility when it comes to repayment.

For example, there are DSCR loans available with interest-only payments and even 40 year terms. Both options would not be available with regular conventional loans.

However, there are also some disadvantages to consider before taking out a DSCR loan. One downside is that these loans typically require a higher down payment than traditional loans. As stated previously, normally the minimum down payment is 20%. In addition, these loans may also carry higher interest rates than conventional mortgages.

WHO SHOULD CONSIDER GETTING A DSCR LOAN

These mortgages are strictly for income producing properties. Also, if an investor has been unable to obtain financing through a conventional mortgage, this would be a great option.

Remember, DSCR loans are also available for refinancing. This means that if an investor needs to refinance a property from short-term financing such as a hard money loan into a longer term option, this can help.

IN CONCLUSION

DSCR loans are becoming increasingly popular among real estate investors because they are easier to obtain than regular conventional mortgages.

They require less personal documentation, lower credit scores and evidence that the property can generate enough income to cover the loan, tax and insurance payments is all that is needed to qualify. There are a few guidelines that borrowers should be aware of before taking out a DSCR loan, such as the maximum loan amount not exceeding 80% of appraised value and the property being income-producing.