DSCR Loans are a type of non-qualifying mortgage
DSCR loans are a specific kind of loan or mortgage product that are underwritten based on the soundness of the business plan rather than the soundness of the borrower’s personal income. DSCR stands for debt service coverage ratio. This is a calculation used by banks to determine the ability of the business or borrower to repay loan obligations.
In real estate, this translates to the following calculation:
DSCR = Net operating income (NOI) / Debt payment
Where NOI = (Gross revenues or rents) — (Expenses).
Example Property for DSCR Loan
Let’s look at an example.
You are under contract to purchase a single family house on123 Main Street for $200,000. In your analysis, you have determined that the monthly rent will be $2000. Is this a good investment property? At first glance, you know this property perfectly fits the 1% rule of real estate, which is a quick screening tool to help select cash-flowing deals for further evaluation.
The 1% rule states that if monthly rent represents 1% or greater of the property’s purchase price, this may represent a cash-flowing property.
You have already performed a second analysis to determine the NOI will be $1,385.
And in order to make the purchase decision, you spoke to the lender and determined the rate and terms you would receive for a mortgage. For example, for 75% loan to value (LTV), 30 year fixed DSCR loan, you will be offered a 7% rate.
In this case, the DSCR is calculated as follows:
DSCR = $1385/$992 = 1.4
For this property, the income after expenses is 40% more than the debt service obligations.
Although different lenders will have different criteria, there will be a minimum threshold at which the loan will be granted, such as DSCR equal or greater than 1.2.
If DSCR is less than 1, then the debt obligations exceed the net income from the property after expenses, and the business (the property) will not have sufficient income to meet the debt obligations without outside assistance. This property will not qualify for a DSCR loan.
The higher the DSCR, the stronger the underwriting for the property.
Should I use a DSCR Loan? What are the advantages and disadvantages of DSCR Loans?
Advantages of DSCR Loans
There are several clear advantages to using DSCR loans.
- The borrower’s personal income and debt-to-income ratio are not used to underwrite the loan.
- There may be significantly less paperwork required to complete the loan application. For example, paystubs and personal tax returns are not required.
- DSCR loans are better options for self-employed people who may have a harder time qualifying for mortgages based on their personal income.
Disadvantages of DSCR Loans
Just as there are advantages, there are clear disadvantages to using DSCR Loans.
- Interest rates may be higher than conventional mortgages, which drives up the cost to borrow. Because of the higher debt payment, monthly cashflows may be lower than loans obtained with conventional financing.
- Closing costs may be higher, requiring more cash out of pocket at the time of purchase.
- Fewer lenders are available who offer this loan product.
How to obtain a DSCR Loan
Numerous banks and private companies offer DSCR Loans.
- Beeline. As a young, small company, they offer excellent and personalized customer service.
- Angel Oak Home Loans. They offer good customer service and lending in dozens of states.
- Hometown Texas. Specializing in loans for investors.
The Bottom Line About DSCR Loans
DSCR Loans are a useful type of mortgage product for buyers who are purchasing investment properties. They offer flexibility and reduced paperwork at the cost of being a more expensive loan.
Do the math, shop around, but don’t ignore DSCR loans as a powerful option for purchasing investment properties, especially if you don’t qualify for conventional financing.
