How A DSCR Loan Can Help You Invest in Real Estate

How A DSCR Loan Can Help You Invest in Real Estate

Executive Financial Group
Executive Financial Group
Published on March 30, 2023
Invest in Real Estate

How A DSCR Loan Can Help You Invest in Real Estate

Owning investment property is a terrific way to generate passive income. And, with limited housing inventory nationwide, potential investors see multi-family properties as a hedge against inflation, a steady source of income, and a wise way to invest in real estate.

Verify your mortgage eligibility (Sep 22nd, 2023)

At the same time, if you want to invest in real estate, getting the necessary financing has historically been significantly more difficult than securing a traditional mortgage for a single family home. This is because traditionally most lenders see financing rental properties to be a significantly higher risk.

If you're looking to purchase investment property the answer to your securing the mortgage you need to invest in real estate could be a Debt-Service Coverage Ratio (DSCR) loan. Before diving deeper into what a DSCR loan is and how it works, let's define what DSCR is.

What is DSCR Loan?

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Debt-service coverage ratio is defined as the "ratio of cash available to service your debt.” In other words, it is a measurement that defines how much money you have available to pay both the principal and the interest payments for your loan. The ratio itself compares the target property's net operating income (NOI) with the target mortgage debt service on an annualized basis.

Your DSCR is significant because it provides lenders significant information about whether you (as the borrower) have access to enough cash flow to service your debt. A high enough DSCR provides some security to the lender that you're unlikely to default on your loan payments.

DSCR shows if a real estate property is making enough money to cover the mortgage or not. When a real estate investor applies for a new loan or refinances an existing mortgage, lenders evaluate the debt service coverage ratio as one indicator to calculate the maximum loan amount.

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In the commercial context, DSCR is used by lenders to determine whether a property will produce enough income to cover the monthly debt payments. This allows businesses with less-than-stellar credit ratings or insufficient collateral to secure financing.

Calculating Your DSCR

DSCR lenders use a ratio known as the DSCR ratio to measure whether your property meets the lending criteria. The ideal DSCR ratio is more than 1. The higher the DSCR ratio, the better. A DSCR ratio of 1.00 indicates that the borrower will have adequate cash flow from the property to pay off the loan.

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If the DSCR ratio is 1.25, the borrower can make loan payments with some extra room. A percentage of 1.50 would provide even more breathing room for the borrower and so on. Again, lenders typically require a minimum DSCR ratio of 1 to process your DSCR loan.

Calculating your DCSR ratio is a rather straightforward formula:

  • DSCR = NOI (Income - Expenses) / Total Debt Service
  • Net Operating Income = Revenue - Operating Expenses
  • Total Debt Service = Current debt obligation

The DSCR reflects the ability to service debt given a specific income level. The ratio expresses net operating income as a multiple of debt obligations due within one year, including interest, principal, and lease payments.

Verify your mortgage eligibility (Sep 22nd, 2023)

The DSCR is relevant because it is a financial measure providing lenders with essential information about the risk they assume with each loan they make. It indicates to lenders whether a borrower will be able to pay their debts for a commercial or multifamily property. A higher DSCR will also give you more leverage (i.e. bargaining power) with your lender.

What is a DSCR Loan?

A Debt-Service Coverage Ratio (DSCR) loan is a particular type of loan that investors can tap to finance the purchase of multi-family and commercial real estate. Being centered on how much cash flow a business generates each month compared to the amount of debt service payments the business must pay makes DSCR loans distinctive.

Verify your mortgage eligibility (Sep 22nd, 2023)

The DSCR loan is intended for real estate investors and mortgage brokers who want to qualify for a mortgage based on cash flow generated by their investment property instead of using income proof, tax returns, employment information, etc. The only requirement for a DSCR loan is your ability to pay mortgage payments through the property's rental income.

Because a DSCR identifies a borrower's ability to repay without requiring income verification, lenders use it to assist real estate investors qualify for loans. Some real estate investors might not be eligible for a standard loan because they deduct expenses from their properties.

These real estate investors can qualify for the debt service coverage ratio loan more efficiently since they are not required to provide proof of income in the form of tax returns or pay stubs, which investors either don't have or don't accurately reflect their real income due to write-offs and business deductions.

Verify your mortgage eligibility (Sep 22nd, 2023)

The DSCR loan is a good option for investors who do not want to provide employment information, tax returns, pay stubs, W2s, etc. It may be the best option for self-employed borrowers with very complex incomes looking for an investment property, as it addresses the problem of having to deal with complex tax returns.

A DSCR loan is an excellent option for investors who want to buy and hold real estate, as well as a great option if you own several investment properties and have reached the point where a traditional lender won't finance more properties.

Qualifying for a DSCR Loan

Verify your mortgage eligibility (Sep 22nd, 2023)

To qualify for a DSCR loan, the property's rental revenue must meet or exceed the lender's coverage ratio criteria. The coverage ratio, which varies based on the lender and borrower, is calculated as monthly rental income divided by mortgage payment. It normally ranges usually ranges from 1.0x to 1.5x. Your ability to borrow a particular amount depends on the mortgage rate and program.

The application procedure is streamlined and could take less time than a standard investment property mortgage because eligibility for a DSCR mortgage is based primarily on the rental income produced by the property rather than your personal income.

A real estate investor who wants to buy or refinance an investment property but does not have enough personal income to be accepted or does not want to give their tax, financial, and job paperwork is a good candidate for a DSCR loan.

Verify your mortgage eligibility (Sep 22nd, 2023)

The rate you will receive from a lender is based on:

  • How much rent does the property generate.
  • How strong the debt servicing ratio and Loan-to-Value is.
  • Can you make a good sized down payment to protect the lender?

The stronger the debt servicing ratio and Loan-to-Value the better the rate you can expect.

Why Look to Executive Financial Group For Your DSCR Loan

Verify your mortgage eligibility (Sep 22nd, 2023)

As a broker, the Executive Financial Group (EFG) works with lenders who offer different DCSR ratio tiers of what's acceptable to make a loan. We even work with some lenders who will do a DSCR loan on mixed-use properties. In other words, we can almost always find a lender for your particular needs and circumstances.

So, if you're looking for the best way to finance an investment property in today's market we should talk. Let's connect so we can answer all of your questions and get you on the way to purchasing that investment property!

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Executive Financial Group
Executive Financial Group East Greenwich
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(401) 735-8100

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