Demystifying DSCR Loans
Authors: Vadim Shtil & S.J. Antonucci
After hearing from so many clients with questions about DSCR Loans, we decided to put together an informative blog post to answer all of your questions about DSCR financing so that you'll have the knowledge you need to make the most educated decisions about your next Real Estate Investments! Knowledge is Power!
Click the Arrows on the side to expand the topics and get your DSCR questions answered!
What Are DSCR Loans?
DSCR Loans are a type of investment property loan that qualifies the property, not the individual borrower, meaning: 💵 The loan is based on the property's cash flow, not the borrower's personal income. 💰
DSCR stands for Debt Service Coverage Ratio, which is a measure of an entity's cash flow related to its debt obligations. The DSCR basically measures how much cash flow is available to pay current debts. DSCR Loans are a type of Investor Loan used to purchase non-owner occupied investment properties.
The DSCR calculation reveals if a real estate property is cash flowing enough money to cover the mortgage payment. DSCR loans are designed for Real Estate Investors who want to qualify for a mortgage based on cash flow generated by their investment property instead of qualifying for the mortgage based on full documentation income proof, like tax returns and employer pay stubs.
These loans have been increasing in popularity and for good reason: they are designed to be available to both newer investors as well as seasoned real-estate gurus and make buying investment properties smooth and easy with fast closings.
How Do DSCR Loans Work?
DSCR loans do have some similarities to regular mortgages as they require a downpayment, a certain credit score, and reserves, but they are vastly different in terms of how the income qualification process works. Lenders will evaluate your DSCR before making a loan. Most lenders demand that their clients' property have a DSCR ratio of 1. A DSCR ratio of 1 indicates that the borrower will have adequate cash flow from the subject property to cover the monthly payment. Some banks may offer DSCR loans with a ratio of less than 1, as low as 0.75, so you'll want a good broker to guide you to find the right product for your needs. 🍀 Luckily, if you're reading this post, you're most likely working with Vadim Shtil, an independent mortgage broker, who will shop all the banks to find you the best loan program for your exact situation.
How To Calculate DSCR For A Real Estate Loan?
To put it simply: Annual Gross Income divided by Debt Obligations equals Debt Service Coverage Ratio.
If you are part of the real estate investing world, then you probably have heard that properly calculating a property's debt service coverage ratio (DSCR) is crucial.
The formula is quite simple, but first you must be familiar with another acronym: PITIA.
PITIA stands for principal, interest, taxes, insurance and association (HOA fees).
To calculate the DSCR, take your annual rental income (numerator) and divide it by the property's annual PITIA (denominator). The result is your DSCR.
For example, if you have a property that rents for $2,500 a month, and the monthly mortgage payment, including taxes, insurance and HOA dues, is $2,000:
$2,000 / $2,500 = 1.25
Your property has a DSCR ratio of 1.25
✅ Calculating the DSCR can help you see the overall return on a property based on your estimated monthly income against your monthly expenses.
✅ By being able to calculate the DSCR, you can better judge the value of a property and make smart decisions when it's time to purchase a new property.
How Do Banks Determine DSCR Rental Income?
If you're using a DSCR loan to purchase a property, the bank will order a special appraisal that includes a rent survey. The appraiser will include information about prevailing rents in the neighborhood based on comparables and this data will be used to determine how much rental income the property is likely to receive.
For a DSCR refinance loan, there is still an appraisal that includes ordering the rent survey which includes expected rents, but the refinance loan will also look at the rent on the current leases.
Who Are DSCR Loans Good For?
DSCR loans are fabulous for all types of investors!
The DSCR loan is a great choice for investors who do not want to provide employment information, tax returns, paystubs, W2s, etc. It's an ideal loan for self-employed borrowers looking for an investment property, as it addresses the problem of having to deal with complex tax returns. It can be a great option for someone who owns several investment properties who has reached the traditional limit on conventional mortgages.
DSCR loans aren't used just for purchases - they can be used for refinances as well - including cash-out refinances for investors looking to pull money from their property's equity to use for further investments.
If you already own an investment property, you can use a DSCR loan to do a: 💸 cash-out refinance to use towards
💰 a downpayment / initial investment
🏘️ to buy your next rental property
🏡 to grow your portfolio!
If you're ready to use a DSCR loan to pull money from your property's equity
to fund your next Real Estate Investment purchase,
What Are The Pros & Cons of DSCR Loans?
DSCR loans provide great flexibility, allowing Real Estate Investors to find alternative ways to fund their projects.
One of the significant advantages of a DSCR loan is that it does not require employment verification, proof of income, or tax returns. Instead, the lender is only interested in the cash flow generated by the subject property.
DSCR loans can offer quicker closing times and you could commit to several properties simultaneously as you're growing your investment portfolio. Additionally, with the cash-out refinance option you can take out cash from your existing property's equity to use towards further investments. DSCR loans can be ideal for both new and experienced inventors, whether you're getting started with your first property, or taking your business to the next level.
DSCR Loans require on average an initial investment of 20% - 25% as a downpayment and are geared towards borrowers with good to great credit scores.
The main advantage of a DSCR Loan is Simplicity: 📝 Not having to provide financial documents,
📋 Eliminating unnecessary conditions,
⏰ and Being able to close in the quickest amount of time.
How Different Are DSCR From Conventional Loans?
DSCR loans allow for regular people to easily jump into the market to purchase real estate investment rental properties.
Conventional Loans take longer to close than a DSCR loan, mainly because an underwriter has to go through a ton of income documents, compared to DSCR loans which require much less documentation.
Conventional mortgages look at your past income as reported on your income taxes and your eligibility for financing is based on your full income documentation, including W2s, paystubs, bank statements, and tax returns. However, with DSCR loans, underwriters look forward, and measure the potential earning power of the property you're buying, using the property's expected rental cash flow to approve the loan.
✅ Fast Closing
✅ Limited Paperwork
💯 DSCR Loans
So if you want a FAST closing loan with limited paperwork, DSCR could be the perfect match for your investment property financing needs.
What Kind Of Property Can I Buy With A DSCR Loan?
There are many eligible property types, including:
Single Family Residences
Multi Family: Duplexes and Multi-Unit Properties
PUDs (planned urban developments)
DSCR loans typically cannot be used to purchase mobile homes or vacant land.
Investors have used DSCR loans to buy properties for traditional long term rentals, mid term rentals including furnishing the home to rent to travel nurses, or even to buy Airbnb vacation homes for short term rentals.
So, are you ready to get started on a DSCR Loan for your next Investment Property?
We hope that this article has helped to Demystify DSCR loans for you and that after reading this post you feel armed with knowledge. Please share this post with your friends to spread awareness and help others to get informed.
At Shtil Group, we have a passion for helping people to achieve a better financial standing in their lives. Let's turn your Real Estate Dreams into Reality. We're here to guide you every step of the way.