Why Do I Want A DSCR Loan?
I have been a real estate investor for more than 30 years and I can tell you that DSCR loans are the best thing that have ever happened to me. Prior to my first DSCR Loan in 2022, it was so hard for me to qualify for real estate loans. There are a few reasons why. One, I am an investor so I don't have a W-2 like normal people do. Lenders don't even know how to process that. Two, I own several investment rental properties and when I apply for a loan, a lender has to dig through my tax returns and analyze every single property I own.
Truthfully, your average lender does not understand a real estate investors tax returns (I barely do myself and they are mine). A few will really dig in and add back depreciation etc., but loans like this can take months to get, require a lot of back and forth requests for bank statements, tax, utility and insurance bills (on every property I have) and the loans are costly - meaning I have to pay a lot of points and fees to get them.
Of course, I've been dealing with this for decades. It is just the way it was. Real estate was my business, I am an investor, so I found good, smart lenders and worked with them whenever I found an excellent investment opportunity - and paid a lot for that privledge.
All that changed in 2022. I was buying a small rental home in Sun City, Arizona and I started to look for a lender to finance the deal. I visited the Scotsman Guide website to do a lender search and I heard about these new, DSCR loans made just for real estate investors like me. I took notice!
I read all about them. They were loans specifically for investment properties. In other words, I could not use the loan to buy a property for myself or my family to live in. The tenant had to be an unrelated party. Also, I could not buy the property in my own personal name. I had to buy it in an LLC or some other business entity. I already set up a different LLC for each investment property I own, so that was no problem for me.
I started to call a few DSCR lenders to get more information and learned that DSCR loans are based only on the investment property itself; not my tax returns, my personal income and expenses or any of the other properties I own. This meant the lender was not going to ask for my tax returns or anything else about me really. Well, that's not exactly right. They did need to run my credit score and they did want to know my real estate experience level. But that was it. There would be no months and months of them scrutinizing every investment I own.
I finally selected a lender and it was absolute easiest loan I ever received. They asked for the particulars of the property, my experience as an investor and the loan process began. About 4 weeks later we were ready to close. I think I gave them the HOA document and a copy of the previous owners tax bill and an insurance bill my agent generated for me, that needed to pay at the closing. That was it. We closed and I rented the property a week or so later.
What Is Debt Service?
Debt Service is just a fancy way of saying mortgage payment - one that includes the property taxes, insurance payment and any HOA dues as well. Let's say you are buying a $250,000 property and your DSCR loan will be 80% of that amount or $200,000. For easy math, let's assume you get a 10 year interest only loan at 6% interest. This means just what it says, you are just paying interest on this loan. You are not paying down any of the principal balance. I like loans like this because it keeps the mortgage payment low so the properties ability to cash flow nicely is much greater.
So there are a few expenses to consider that will make up the debt service; interest on the loan, property taxes, HOA association dues and property insurance.
In this scenario, your monthly interest would be $1000 = ($200,000 x .06)/12)
Let's assume the property has a $50 monthly HOA fee, property taxes are $150/month and homeowners insurance is $100/month. This means, the properties total debt service is $1,300. This is the figure that DSCR lenders use to calculate how much they will loan on that property.
We need to know how much income the property will generate as well. Let's say you have contacted a few property managers in the area and they have told you the house will rent for approximately $1,650.
To calculate the DSCR we divide the income $1,650 by the debt service $1300 and this gives us the debt service coverage ratio of 1.27 (1650/1300) = 1.27
The higher the ratio, the better your ability to make the mortgage payment to the lender.
Now, each lender has their own calculation they use. Some more aggressive lenders will accept a DSCR of 1x. Other more conservative lenders require a 1.25 DSCR.
Keep in mind, if the property is not leased yet, as you are buying a vacant property, or one that the seller is moving out of, most DSCR lenders will determine what the neighborhood rents will be and they will use that to determine the DSCR of that property.
If you do already have the property leased, at a certain rate, and can provide that signed lease to the lender, they will usually accept the rental rate on your lease when calculating the coverage ratio for the loan amount.
We want DSCR loans because they make it so easy for real estate investors like me, and hopefully you, to buy an investment property.
Does The Property Need to Be Leased to Get a DSCR Loan.
No! That is one of the beautiful things about a DSCR loan. They are truly made for investors. Lenders realize you may be buying a home that needs a bit of TLC and will be vacant at closing. That's just fine. They will do a market rental study and determine the DSCR ratio that way.
Do DSCR Loans Require an Appraisal?
Yes, the lenders I have worked with all do. I've paid between $600 to $800 for a DSCR loan appraisal. The lender wants to make sure the property is worth the loan amount they are placing on the investment and I can certainly understand that.
Do DSCR Loans Have a Prepayment Penalty?
Yes. This is a very important consideration when getting a DSCR loan. They are not for properties you plan to fix and flip. This is because most DSCR loans have 5 year prepayment penalties. I've seen them when the prepayment penalty is 5% for the first 5 years of the loan. This means if you pay off the loan in the first five years, you will owe a penalty of 5% of the total loan amount. More often I've seen a prepayment penalty that scales down 5/4/3/2/1. So, in year 1 of the loan, the penalty is 5% of the loan amount. In year 2 of the loan, the penalty is 4% of the loan amount, and so on. The prepayment penalty is a very important thing to consider. If you plan to hold the investment short term, perhaps less than 5 years, a DSCR loan might not be right for you.
Do DSCR Loans Have Higher Interest Rates?
It is my experience that they do not. that is why makes them such incredible loans for real estate investors.
Do DSCR Loans Require a Down Payment?
Yes, the lender will want you to have some skin in the game. Generally, most DSCR lenders will loan up to 75% loan to value. This means they want you to have 25% as a down payment on . Some more aggressive lenders will require lower down payments but they might also charge a bit higher interest rate for the higher loan to value LTV rate.
Can I use a DSCR Loan For a Personal Home Loan?
No. you definitely can not. They are specific loans designed for real estate investors for investment properties. In other words, you can not take out a DSCR loan for your personal residence home loan.
Why Do I Want a DSCR Loan?
Keep in mind, DSCR loans, or Debt Service Coverage Ratio loans, are a special type of financing designed for real estate investors. Unlike traditional loans that focus on your personal income, DSCR loans look at how much money a property can make. This is really helpful for people who want to invest in real estate but may not have a steady paycheck or have complicated income situations.
If you want to become a real estate investor, or already are one, DSCR loans are the unicorn loans we've all been waiting for.
Imagine you can buy a rental property. The money you earn from renting it out, rental income, is all the lender needs to determine if you qualify for the loan. This means you don't have to provide your personal financials or tax returns. The DSCR loan is made on the merits of the real estate investment you are hoping to buy. All the lender cares about is how well the property can generate cash flow.
This approach makes DSCR loans particularly appealing for a variety of investors. Whether you are just starting out or have been investing for years, these loans can offer a way to finance your next property without the usual hurdles. For example, if you have a property that earns enough rent to cover its mortgage, you could qualify for a DSCR loan even if your personal finances are complicated.
How DSCR Loans Work?
Understanding how DSCR loans function is crucial for anyone thinking about borrowing. These loans are unique because they focus on the property’s ability to generate income rather than the borrower’s personal finances. This is a big relief for many real estate investors.
The key to DSCR loans is the calculation of the Debt Service Coverage Ratio. This ratio helps lenders determine if the rental income from a property is enough to cover the loan payments.
Let's Review The DSCR Calculation Again
To calculate the DSCR, you can use this formula:
DSCR = income / Total Debt Service.
Take the money your property earns and divide it by the total amount you have to pay for the loan each month eg: payment, HOA, property taxes and property insurance.
A DSCR of 1.0 means that the property’s income just covers its debt. If the DSCR is above 1.0, it indicates that the property is making more money than it needs to pay its debts. That’s a good sign!
Lenders generally prefer a DSCR of 1.25 or higher. This higher ratio shows that the property not only covers its expenses but also has some extra cash flow, making it a safer bet for lenders.
Another Example
To make this clearer, let’s look at an example. Imagine you own a rental property that generates <b>$5,000</b> in rental income each month. If your monthly mortgage payment is <b>$4,000</b>, the calculation would look like this:
<b>DSCR = $5,000 (NOI) / $4,000 (Total Debt Service) = 1.25.</b>
In this case, your property is in a good position because it has a DSCR of <b>1.25</b>. This means you have a positive cash flow, which is what lenders like to see when considering your loan application.
Do DSCR Loans Report To Credit?
Yes, DSCR loans do report to the credit bureaus.
Do DSCR Loans Require Personal Guarantee?
Yes, I have 4 DSCR loans currently and I have had to sign a personal guarantee on all of them. This is worrisome if you plan not to make your payments. I however, do plan to make all of mine :)
Do DSCR Loans Have PMI?
No. PMI is private mortgage insurance people pay on personal home loans when they make smaller down payments. As DSCR loans are investor loans, and require adequate down payments at the time of purchase, they are not loans that require PMI.
Do DSCR Loans Require a Credit Check?
Yes, the lender will check your credit. Each lender has a different minimum credit score requirement but generally the lender cares more about the income and debt service of the investment property than your credit score. However, if you want to become a real estate investor, my advise to you is to always pay your bills on time and keep your credit card balances low. It very important you keep your credit score as high as possible. That is less important with a DSCR loan, but always a good thing to manage well anyway.
Do DSCR Loans Require Tax Returns?
No. No tax returns are required. That is one of the real beauties of a DSCR loan and the thing I love most about them.
Do DSCR Loans Require 20% Down?
Generally, DSCR loans will require 20 to 25% down payment. Occasionally they might require less, but you will most likely pay a higher interest rate on the loan so keep that in mind.
Are DSCR Loans Interest Only?
DSCR loans can be fully amortizing or interest only. Interest only just means that your mortgage payments are just interest. So, you are not paying down the principal balance of the loans. I really like interest only (IO) DSCR loans because they keep the mortgage payments low and really help the property generate terrific cash flow.
Are DSCR Loans Fixed Rate?
While I do believe some DSCR loans are floating or adjustable rates, most are fixed rate. This means if you have a 10 year loan, at 6% interest, that rate will be fixed the entire 10 years of the loans. Of course every lender has their own way of doing things, and DSCR loans are a newer product so things are changing all the time. You will want to discuss all the different DSCR loan types with your particular lender to make sure you get the loan that is right for you.
Are DSCR Loans Assumable?
In my experience so far, my DSCR loans have not bee assumable. Definitely check with your particular DSCR lender to find out if they offer assumable products.
When Did DSCR Loans Start?
I am told that DSCR loans originated in residential real estate after the 2008 financial crisis. However, I first heard of them after COVID. My DSCR lender told me they started making DSCR loans in 2022-2023. All in all, they are a newer product. Many people, primarily real estate investors, still do not know about DSCR loans. Or if they do, they think they are more expensive or too good to be true. I can tell you from experience, they are not too good to be true. They are real and they are a very good thing for investors who find it difficult to qualify for real estate loans.
How Many DSCR Loans Can You Have?
Each lender has a different requirement. Some lenders say you can have up to 10 loans with them. Others say it's a dollar amount, maybe $3,000,000 in loans. So, once you have that many loans with that lender, you might need to find another one. But there are so many DSCR lenders out in the marketplace, I wouldn't let that deter or worry you.
Are DSCR Loans Hard to Get?
I know we've gone over this quite a bit but I want to reiterate it here because I'm so thrilled to be using DSCR loans in my own real estate business. DSCR loans are not hard to get at all. They are based on the income potential of a property, not your personal tax returns or income and expenses. The lender will run your credit but they are far more concerned with the income the property will generate and it's ability to pay the debt service (mortgage, HOA, taxes and insurance). You can apply quickly and provide just a few documents to the lender and you are on your way.
How Long Does It Take To Get a DSCR Loan?
My experience has been it takes about 4 weeks. It's a quick and easy process. You contact a DSCR lender, go over their DSCR loan rates and discuss the pros cons of each loan they offer in terms of term, rate, prepayment penalties etc. The lender will do some calculations on the property and determine the ratio DSCR and let you know the loan amount they will lend on the asset. You can decide which loan you want to move forward with and the loan process begins from there. Generally you pay the appraisal fee and that locks the rate.
Sometimes the rate will lock later on so you will want to discuss that with the lender to be sure you know when the rate locks. That just means the rate quoted is the rate you get. If the rate did not lock, and 4 weeks later, when you are ready to close, rates are much higher so now your payment will be more, and perhaps loan amount less, this could be catastrophic to your deal. So discuss the rate lock with your lender, know when it locks and lock it when you are sure it works for you.
In my experience, my rate has locked when I pay for the appraisal!
Why Consider a DSCR Loan?
Why not should be the question! DSCR loans are awesome loans for real estate investors who plan on keeping their investment for 5 or more years. I tell my son all the time how many more properties I would own if DSCR loans had been available to me in the 1980's, 90's and early 2000's. There is no reason real estate investors should not be using them to their full advantage today to build huge real estate portfolios if that is their dream.
DSCR loans are very attractive financing options. If you’re looking to invest in properties, understanding these loans can really be a benefit to you.
Advantages
Here are the key benefits of choosing a DSCR loan:
Considering these advantages, DSCR loans can be a smart choice for many investors. They allow you to focus on the potential of your properties rather than the complexities of personal income.
Who Can Benefit from DSCR Loans?
Anyone who wants to invest in rental properties. Generally, DSCR loans work on properties from 1-4 units. However, I have met some DSCR lenders who will make loans on 1-10 unit properties as well. But those lenders are much more rare.
DSCR loans are particularly suited for:
Like I said earlier, I wish so badly DSCR loans had been available when I was a young real estate entrepreneur. I'd have let DSCR loans guide my real estate career. I tell anyone who will listed today about all the benefits of DSCR loans. Anyone who doesn't take advantage of them is making a real mistake, in my opinion.
If you need help getting ready to buy your first real estate investment, and need a plan to save the funds necessary, I highly recommend you check out my Definitive Annual Budget. I created it for myself so I could figure out how much income I had coming in, how many expenses I had going out, and to make a plan to save for my investments. I decided to share it with others in order for them to take control of their finances too and start investing!! I made it simple to use. Don't let a disorganized financial situation dissuade you from investing in real estate today. Get on track here.
Qualifying for a DSCR Loan
While DSCR loans are more flexible than traditional loans, there are still key requirements to keep in mind. Knowing these criteria can help you prepare for the application process and increase your chances of approval. You will be required to have a certain credit score but it is not super high. Of course, the higher your score the better, but most DSCR lenders are able to work with borrowers with much lower credit scores.
Key Requirements
To qualify for a DSCR loan, borrowers typically need to meet the following criteria:
By understanding these requirements, you can better prepare yourself for the loan application process. If you meet these criteria, you may find that a DSCR loan is a great option for your real estate investment needs. As always, consider speaking with a financial advisor or mortgage professional to get personalized advice and guidance tailored to your situation.
Invest Smarter with DSCR Loans
I really believe that DSCR loans provide a streamlined and flexible financing solution for real estate investors. These loans focus on cash flow rather than personal income. These loans are unique and available on investment properties only. They are a wonderful vehicle to either get started investing in real estate or take your career to the next level for seasoned pros. These DSCR loans definitely provide unique advantages over conventional loans that can help you quickly achieve your real estate goals.
