DSCR Loans

DSCR Loans

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Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for investment advice.

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DSCR stands for Debt Service Coverage Ratio. This is also referred to as a Non-QM (Non-Qualified Mortgage) Loan. A Non-QM loan is a type of mortgage loan that allows you to qualify based on alternative methods, instead of the traditional income verification required for most loans. I have also seen many banks advertising this type of loan as an Investor Cash-Flow Mortgage. Essentially, a DSCR Loan is a mortgage loan type that prioritizes the property's cash flow over the borrower's personal income. Unlike conventional mortgages, DSCR mortgages are not backed by entities like Fannie Mae and Freddie Mac. Your debt service coverage ratio is defined as the “ratio” of cash available to “service” your debt. DSCR mortgages look at the cash flow of the property itself to determine the borrower’s ability to repay the loan. Or in other words, the debt service coverage ratio lets the lender know how to determine a borrower’s ability to pay off their DSCR mortgage. So instead of having to qualify for a loan utilizing your work history and measuring your Debt-To-Income (DTI) Ratio, it alternatively utilizes the properties own performance, the projection of what the asset will cash flow, to qualify the loan.

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This structure of loan has been around for a long time but has been primarily utilized in the commercial lending space. The recent spark from this loan program comes from its scope broadening to the residential and multi-family asset class.

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Formula to calculate a DSCR:

DSCR = Net?Operating?Income?(NOI) / Total?Debt?Service

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Debt service is all the expenses that the property is projected to have. At a minimum, this is the PITI (Principal, Interest, Taxes and Insurance).

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Example:

DSCR greater than one (>1) This indicates that the NOI exceeds debt service obligations. A DSCR of 1.2, for instance, suggests that the company has 20% more net operating income than it requires to cover its current debt payments. If a company's NOI is $120,000 and its debt service is $100,000, then DSCR = 1.2.

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What Is A “Good” DSCR?

Most business lenders require their borrowers to have a DSCR ratio higher than 1.00. In fact, the minimum for most lenders is typically around 1.2. A DSCR ratio of 1.00 means that the cash flow generated from the property in question will be exactly enough to service the borrower’s loan. A DSCR ratio of 1.2 means that the borrower will be able to service their loan, with some added cushion. There are No-Ratio DSCR Loans available, but as you can imagine, the terms of these types of loans are not favorable.

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The pros to this type of loan are:

1.???? Lenders don’t consider personal income

2.???? Fixed loan rate

3.???? Faster closing times

4.???? You can commit to multiple properties at once

5.???? All rental types eligible

6.???? There is no max for number of these types of loans

7.???? Can borrow as an LLC or Entity

The cons to this type of loan are:

1.???? Large down payment (typically around 30%)

2.???? Higher loan cost (fees and points)

3.???? Lending purchase price caps (most have $3M-$3.5M cap)

4.???? Required cash reserves (many banks require up to six months)

5.???? Prepayment penalties

6.???? Min Credit Score (typically 650 to 700)

7.???? Slightly higher interest rates (fluctuates greatly depending on your ratio)

8.???? Lender measures potential income, not necessarily what the property will actually make

9.???? Rentals only (not primary residences or fix and flips)

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Although you will not need your personal DTI to qualify, you will need to be able to show funds for reserves. Large down payments plus hefty reserves means that this loan is not for individuals with minimal resources. These loans are more directed at individuals who have funds to deploy but the normal qualifying metrics has them at a higher DTI threshold than banks will allow for Fannie Mae and Freddie Mac backed loans.

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Many investors are running into the problem that conventional means require two-year tax statements for qualifying income received on investment properties. If a person has purchased multiple properties in the past couple years (even if the properties are cash-flowing well), many institutions will count the mortgages against their debt but will not offset it with any income because of the two-year tax statement requirement.

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With the Fed (Chair Jermone H. Powell) raising rates 11 times since March ‘22, a secondary effect is the tightening of lending thresholds by institutional lenders that have been implemented across the board. Investors have found that this DSCR loan program is an opportunity to continue to buy great deals in this slowing market, even when lending policies are tightening. This is one resource that is currently available in the lending market today, that provides a unique leverage opportunity to offset the institutional tightening that we are all seeing. Factors such as interest rates, loan-to-value ratios, repayment terms, and overall borrowing costs should all be considered to make an informed decision that aligns with the specific needs and goals of each individual project.

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This is not a one-click option that fixes all the problems we may be facing in this current market. Rather, it is a great tool to be considered for the right property in the right scenario. If you find a great deal, and it is set to cash flow well, don’t let tightening lending policies deter you from your next big opportunity. This is one of several ways to finance a property outside of conventional means.