What is a DSCR Loan? How Investors Can Scale Their Business Using It

What is a DSCR Loan? How Investors Can Scale Their Business Using It

Leverage is a wealth multiplier for real estate investors. When you own a rental property with substantial equity that also has positive cash flow every month, you can borrow money against that property to go buy another one. Keep it up, and you can repeat the process indefinitely. Over time, you can build a massive portfolio of rental units.

Yet many real estate investors, from novices to those with dozens of units, may not fit the standard mold for many lenders. A self-employed person may minimize their income on their tax return to save on taxes, yet to a traditional lender they appear not to make enough money. An experienced investor may have less than stellar credit yet have multiple cash-flowing properties with tons of equity. A person may own their rentals in Limited Liability Companies (LLCs) for asset protection purposes, yet traditional lenders may only want to deal with someone who holds real estate in their own name. Another person who bought in their own name may have hit the limit of 10 conforming loans on investment properties, and to expand they need a new source of financing. Another person may be retired so they don’t appear to have much income, yet they have a knack for negotiating screaming hot deals. How can all of these people obtain the leverage they need to acquire more investment properties?

The DSCR Loan

A loan based upon the Debt Service Coverage Ratio of an income-producing property could be the answer. You see, when buying or refinancing your own home with a conforming loan (you own the property in your own name and the loan meets Fannie Mae or Freddie Mac guidelines), the lender evaluates your debt-to-income ratio, credit score, and income as reported on your tax returns. In other words, the lender evaluates you more so than the property.

With a DSCR loan, the lender puts far more emphasis on your property than on you. The lender wants to know if the property’s rental income can more than cover the operating expenses. A typical minimum DSCR ratio is 1.25. The net operating income (NOI) must be at least 1.25 times the debt service (financing costs). The NOI is the rental income minus the normal expenses, not including financing costs. For example, let’s say the annual NOI is $20,000, and the annual principal and interest payments add up to $15,000. The DSCR ratio is 1.33, meaning that the property’s income easily supports the mortgage payments.

Here are typical features of a DSCR loan:

  • You can take title in a trust, an LLC, or in your own name.
  • Up to 80% Loan-to-Value (LTV) for purchases, and up to 75% LTV for cash-out refinances.
  • Interest rates are higher than conforming loans.
  • Many DSCR loans have a pre-payment penalty for first few years.
  • Typically no limit on the number of financed properties.
  • Various amortization terms, which can include a 30-year fixed rate or even a 40-year fixed-rate loan with a 10-year interest-only option.
  • Borrowers don’t need any income documentation like paystubs, tax returns, or W-2s.
  • Many lenders expect the borrower’s FICO score to at least be in the high-600 range.
  • Some lenders are open to a cash-out refinance shortly after the purchase. (With a cash-out refinance using a conforming loan, you have to wait 6 months after the purchase date.)
  • The borrower typically pays at least 2 points on the loan and probably more.

DSCR loans allow investors to scale their business. If you’re skilled at acquiring and managing rental properties that easily demonstrate a DSCR ratio of at least 1.25, there may not be a limit as to how many units you can acquire. True investors relish the opportunity to let their properties do the talking. Sure, you may pay a little more in interest and fees on a DSCR loan versus a conforming loan, yet that’s the cost of doing business. DSCR loans offer more flexibility and typically require less paperwork to qualify.

DSCR loans can be made by some traditional banks or via other lenders. There are commercial mortgage brokers who will shop around different lenders. Who do you use for your DSCR loan? Drop me a line and share!

Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania.  He became a full-time real estate investor in 2004 after serving in the U.S. Navy.  Tai has made colossal mistakes in investing (and learned some things along the way).  He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics.  Send an email to tai@investandtransform.com.

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