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What is a DSCR Loan and Is It Right for You?

Real estate is a big industry with a lot of moving parts, especially when it comes to facilitating a commercial purchase or sale. From negotiations to appraisals and contracts, there are several different steps to take, and multiple parties involved. One big factor that may help move this type of deal to the finish line quicker is the debt-service coverage ratio (DSCR) loan.

DSCR loans are a special type of loan for real estate investors and mortgage brokers seeking to qualify for a mortgage using the cash flow generated by their investment property instead of traditional income. 

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What is DSCR?

To put it simply, DSCR is the ratio of the net operating income of a business or property to its obligations, such as outstanding debts and expenses. This is a way of measuring whether the entity in question will be able to pay its mortgage from the cash flow generated by the property. This is ultimately the same idea as a debt-to-income (DTI) ratio in residential real estate. The only difference is a DTI is measured using your personal income, not a business income.

How to calculate DSCR

Calculating DSCR is simple. Divide net operating income (NOI) by total debt service (TDS). 

To calculate NOI:

Revenue – Operating Expenses

To calculate TDS:

Principal Payment + Interest Payment + Lease Payments 

For example, if a business has a net operating income of $200,000 and a total debt service of $150,000, the DSCR is approximately 1.33. The business has 1.33 times the cash flow to make payments toward debts. There are also real estate investing apps that can help you track and calculate these important numbers.

What is a DSCR loan?

DSCR loans are ideal for investors who want to qualify for a mortgage based on their investment property’s cash flow. This is in place of tax returns, personal income proof, and other forms of financial verification. It can quickly identify whether a borrower will be able to make necessary payments, helping lenders qualify for loans.

DSCR loans are available from many different types of lenders, including banks, credit unions, and private companies. In turn, they can be used to purchase, refinance, build or even rehabilitate.

Additionally, DSCR loans typically have a lower interest rate than other types of loans because they’re considered less risky. The DSCR gives lenders confirmation that the property will generate enough income to cover debts.

Who is a good fit for a DSCR loan?

This loan is ideal for investors who don’t want to provide employment or tax information to lenders, as well as self-employed borrowers who are living off rental income. An investor with several properties who has reached the traditional credit limit of ten would also be a candidate for a DSCR loan.

How do you qualify for a DSCR loan?

There are no hard and fast rules as every lender will have a different set of requirements. That said, most lenders will require a minimum DSCR that falls somewhere between 1.2 and 1.5. If a borrower’s DSCR falls below this threshold, a lender may refuse the loan or request additional collateral. 

Benefits of a DSCR loan

If you’re a good candidate for a DSCR loan, it’s important to understand the benefits. Here are some of the advantages of going this route:

Faster processing time

Eliminating the need to produce personal financial information leads to a streamlined and quick application procedure.

Personal income is irrelevant

Because DSCR loans don’t evaluate personal finances, they’re more accessible to borrowers without considerable savings or other assets.

It provides opportunities for all investors

Whether you’re new to investing or a seasoned pro with large-scale pieces of real estate, DSCR loans are a smart option. They can provide the funding you need to grow your business and pursue new opportunities.

Although these are some of the big benefits to note, unlimited cash-out options are another appealing factor. Plus, you can commit to several properties at the same time.

What if your DSCR is too low?

If you’re realizing that your DSCR isn’t going to make the cut, there are things you can do now to improve your chances of being approved. First, pay down your existing debt as much as possible. Next, take a look at your operational structure and determine where you can reduce expenses. Identify problem areas and make changes to save money. Eliminating unnecessary costs will improve the big picture. Once your DSCR is higher, you can reapply and begin your search for a real estate agent.

 

Screen Shot 2021 12 28 At 113128 AmLuke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the LA Times, and more.