Here are the basics of how DSCR loans work for your real estate investment.
Finding the right loan isn’t as easy as it used to be.
We’re getting more and more calls asking about different loans. And the most common loan investors want to know about? DSCR loans.
How are DSCR loans changing in this current market? Where will rates go? Who is still offering them? Is a DSCR loan even still a good option for investors right now?
Let’s go over those answers and see how DSCR loans work in today’s real estate market.
The Basics of How DSCR Loans Work
To begin with, the most important thing to know about DSCR loans right now is that they vary from lender to lender. You need to get to know lenders in your area.
Conventional conforming loans are different – they have one main underwriting guideline all lenders follow. For DSCR loans, every lender creates their own requirements, offers, and processes.
How DSCR Loans Differ
Each lender has their own nuances. Any number of these factors can change for a DSCR loan between different lenders:
- Ratio requirements
- Credit score requirements
- Terms and products (interest-only, 40-year, etc.)
- Interest rates
Lenders will also have different restrictions for properties, based on:
- Unit size
- Short-term vs traditional rentals
- Personal name vs LLC name
To be successful with DSCR loans, you need to become a master of which lenders offer what in your area.
You have to be proactive. Lenders won’t come knocking on your door to let you know what products they have available.
How to Connect with DSCR Lenders
With more investors asking for money and less money available, many lenders are overwhelmed. The best thing you can do is be proactive, educated, and prepared with your lenders.
It’s wise to get someone who can help connect you with lenders and products. A place like The Cash Flow Company can help with this aspect of real estate funding. They can advocate for you to make sure you get the best loan for your deal.
How DSCR Loans Work – What is the “DSCR”?
“DSCR” stands for “debt service coverage ratio.” It’s a number that explains cash flow, or money coming in vs money going out.
In a real estate rental situation, there are two important numbers to figure out this ratio:
- Income – rent from tenants.
- Expenses – mortgage principal and interest, taxes, insurance, and any HOA fees.
What Debt Service Coverage Ratio Do DSCR Lenders Take?
If your income 100% covers your expenses with none left over, that’s a ratio of 1:1. Most DSCR lenders require 1:1 as a standard minimum.
DSCRs Lower Than 1:1
Some lenders will go as low as .75, which is called no ratio. That’s if your income from your rental leaves 25% of the property’s expenses left over.
There’s one main circumstance when investors would take a loan with no ratio. If you have a fix-and-flip in a tough spot and need to refinance it into a rental for a short time, a no ratio DSCR loan could make sense.
Making $2,500 rent on a $3,000 per month property is better than spending $3,000 every month for a house that’s just sitting on the market. Some income is better than none.
DSCRs Higher Than 1:1
But the ideal use of a DSCR loan is when you have a higher ratio. This would mean your rent is higher than your expenses, and your property has positive cash flow.
Some lenders require a ratio of 1:2. This requires a much bigger gap between what your tenant pays for the property and what you pay. Hitting this ratio can be unrealistic for many markets. Rents are steadily increasing, but not by that much.
You should verify what ratio lenders use before you even consider closing on a DSCR property. Do your research, learn your lending options, and find out each DSCR lenders’ minimum requirements.
How DSCR Loans Work – How Do You Calculate the DSCR?
So now you understand what the ratio is and how lenders use it… But how do you calculate your DSCR ratio?
You need two numbers:
- The rent you’ll charge (income)
- Mortgage principal and interest, taxes, insurance, and HOA fees (expenses)
Note: utilities and property management costs are not considered expenses on a DSCR loan.
Once you add up your expenses, you have to find out if your rent covers them. To get the ratio number, you divide income by expenses.
If you don’t want to worry about doing the math yourself, you can download our free DSCR loan calculator at this link.
DSCR Loan Calculation Example
Here’s a simple example.
Let’s say you have a single-family property, and the interest and mortgage is $1,000/month. Taxes are $250, property insurance is $150, and there are no HOA fees.
Your total monthly expenses adds up to $1,400.
Now let’s say the rent you can charge based on your property’s location is $1,600.
So, you can divide $1,600 (income) by $1,400 (expenses). You get a ratio of 1.14.
A 1:1 ratio (the typical minimum) can also be called 1. So our 1.14 is higher than the minimum. With a ratio higher than one, you’ll have a much better shot at finding a DSCR lender who will work with you.
If the market in our example went up, maybe you could charge $2,000/month for rent. If your expenses were still $1,400, your ratio would be 1.42. With that ratio, you could likely get a bigger loan and lower rate.
The higher your ratio, the better your opportunities for rates and terms. The lender sees it like this: the more income coming into the property, the more guaranteed it is you’ll pay them back.
Short-Term Rental Options with DSCR Loans
It’s still possible to use DSCR loans for short-term rental units (like Airbnb or VRBO).
However, the requirements may be different for a short term-rental. You can get your DSCR loan for a short-term rental one of two ways:
- You’ll need to have 2+ years of experience with the property, with proof of income for that time. The rental will be treated as “no ratio,” so you’ll get higher rates and lower LTVs.
- They’ll go off of market rent of traditional rentals in the area. If the DSCR with that market rent qualifies, you can get a decent loan.
In either case, DSCR loans for short-term rentals don’t count the rent you receive from guests as the income. The ratio has to be calculated using regular rent rates.
Get Someone On Your Team Who Knows How DSCR Loans Work
You may be stepping into unfamiliar waters with this market, unsure of where or how to get investment loans. Yet leverage will still be vital for your real estate career.
The Cash Flow Company searches every day for the best loans for real estate investors.
If you have a DSCR loan or a deal you need a loan for, reach out to us at Info@TheCashFlowCompany.com.