Tag Archive for: DSCR loan

How can you use the DSCR ratio to calculate DSCR loan amounts?

When getting into the DSCR game, it’s important to run some numbers on the front end to evaluate potential deals. 

How do you know if your property is going to meet DSCR requirements? What’s the minimum loan you’ll need, and what’s the maximum you can shop for the purchase price?

Easy. Start with the DSCR ratio, and then walk through these steps to figure out your payments.

Calculating DSCR Loans

1. Figure Out Local Rents

Using resources like Zillow or rent.com, you can look around to find standard rents for your area. This is the first step in getting future estimates (such as loan total, purchase price, etc.). 

Don’t start spending money before calculating whether or not you’ll actually be able to pay those costs back.

Let’s say standard rent in the area is around $2,500. This means that, in order to break even, we need to keep all of our monthly expenses below that $2,500. 

  • Rents = $2,500
  • Expenses $2,500

2. Monthly Expenses

For this example property, there are three monthly expenses. Taxes, insurance, and HOA fees. Other properties might have additional insurance or fees, so make sure you look at the neighborhood.

Here’s what we’re looking at for this example:

  • Taxes: $1,200/year ($100/mo)
  • Insurance: $2,400/year ($200/mo)
  • HOA: $200/month
  • Total Monthly Expenses: $500

Obviously at this point in the process, these numbers are only estimates. However, if you do research to have informed estimates, you can save a lot of money and headache down the road.

3. The Leftover = Maximum Mortgage Payments

If our estimated rent is $2,500/month and we subtract our $500 of monthly expenses out of that number, we’re left with $2,000/month. 

  • $2,500 (income: rent) – $500 (expenses) = $2,000 (leftover)

Now we’re ready to talk about the mortgage.

The leftover $2,000 is the maximum you could pay each month towards a mortgage. 

If we want to qualify for a DSCR and keep our ratio at 1, this gives us our upper limit.

Translating Expected Expenses Into Your DSCR Loan

So, how do we take this $2,000/month number and translate it into DSCR loan requirements?

How much could you afford in a loan?

The easiest way is to use our updated DSCR calculator. It’s free to download and easy to use!

By inputting the current estimates, you can use this download to calculate DSCR loan requirements. What do you qualify for? What terms can you expect?

Our current estimate would likely qualify for an 8% interest rate on a 30 year mortgage.

With those numbers, we can now really start planning.

The Maximum Loan Amount

As we mentioned above, we recently updated our DSCR calculator to include a worksheet that helps you figure out your maximum loan. Even if you’ve downloaded the calculator before, you can redownload to get the updated version.

You can also use sites like calculator.net, input the numbers, and see what you’re working with.

Once we use our DSCR calculator, we discover that the maximum loan we can get and still keep our DSCR ratio at 1 is around $272,500.

 

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Looking at a DSCR loan calculator and wondering what numbers you need to plug in to make everything come out even? 

If you’re new to the DSCR game, you’ve likely heard people talking about the DSCR ratio and how that number helps you set rents. But how do you actually calculate all of that? 

There are quite a few numbers that go into calculating a DSCR ratio (which is then often used to calculate rents).

What is a DSCR Ratio?

A DSCR ratio is simply the break even point. 

Essentially, you start by adding up all of your monthly expenses (mortgage payments, taxes, insurance, HOA fees, etc.). If you compare that number to the amount you’re charging for rents and those numbers are the same (you’re putting out and bringing in the same $$ amount), then you have a DSCR ratio of 1.

You never want a DSCR below 1 (spending more than you’re bringing in). However, a ratio of 1 simply means that you’re breaking even. In other words, you’re not actually making money unless you can raise the ratio (and raise rents) in order to bring in more money than you’re spending.

Lenders like to see positive cash flow, so it’s typically good to aim for a DSCR ratio of 1.25. That means you’ll make 25% more than you’re spending. 

How to Calculate Your Fixed Costs

The first step of figuring out the ratio is to get a really clear picture of your expenses. Expenses come in two parts: fixed costs and monthly payments for loans. 

Let’s look at fixed costs right now.

These fixed monthly expenses consist of things like HOA fees, insurance, taxes, and other exciting things.

For Example…

Let’s take a peek at some numbers based on a property we reviewed recently:

  1. Taxes. This property had $1,200/year in taxes. Divide that by 12 and you have $100/month. 
  2. Property Insurance. We’re going to look at $1,800/year or $150/month.
  3. Flood Insurance. This property didn’t have any HOA fees, but it did need flood insurance. That comes to $2,4000/year or $200/month.

In total, you have $450/month in expenses for this property before factoring in your mortgage payment.

When working with your DSCR loan calculator, don’t forget about the fixed costs. It’s a critical number in calculating the ratio that’s going to set you up for success.

 

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A DSCR loan is great, but they’ll come into play at a later part of the BRRRR process. 

Let’s start with a real scenario we encountered a few weeks ago. A client from Michigan called. He’s done flips before and even kept a few rentals, but he’s new to the BRRRR method. 

In the past, he’s always used partners or cash to fund his investing. However, this property needs more money.

He’s buying it for $200,000, putting approximately $22,000 of rehab into it, and we’ll estimate closing costs around $7,000. That’s a total of $229,000 for a pretty basic investment property. 

Where can this client find the money, and how can he leverage it to his advantage?

He wanted to know if he could take out a DSCR loan to kickstart the BRRRR process.

Can You Use a DSCR Loan to Begin the BRRRR Method?

The short answer is technically yes. However, since you don’t currently own the property, you can’t claim the equity in it just yet which makes it a not-so-great deal.

For our example client above, a DSCR loan will only cover up to 80% of the purchasing costs. This leaves 20% leftover — a large amount of cash that our client and a lot of newer investors simply don’t have.

Additionally, a DSCR loan won’t cover renovations or closing costs.

If you’re trying to exclusively use a DSCR for a BRRRR, you’re going to see the payments begin to add up really quickly.

It’s typically better to wait until later in the process to bring in the DSCRs.

 

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What do you need to know in order to effectively use a DSCR calculator?

If you’re new to the DSCR game, you’ve likely heard people talking about the DSCR ratio and how that number helps you set rents. But how do you actually calculate all of that? 

What is a DSCR Ratio?

A DSCR ratio is simply the break-even point. 

Essentially, you start by adding up all of your monthly expenses (mortgage payments, taxes, insurance, HOA fees, etc.). If you compare that number to the amount you’re charging for rents and those numbers are the same (you’re putting out and bringing in the same $$ amount), then you have a DSCR ratio of 1.

You never want a DSCR below 1 (spending more than you’re bringing in). However, a ratio of 1 simply means that you’re breaking even. In other words, you’re not actually making money unless you can raise the ratio (and raise rents) in order to bring in more money than you’re spending.

Lenders like to see positive cash flow, so it’s typically good to aim for a DSCR ratio of 1.25. That means you’ll make 25% more than you’re spending. 

How to Calculate Your Fixed Costs

The first step of figuring out the ratio is to get a really clear picture of your expenses. Expenses come in two parts: fixed costs and monthly payments for loans. 

Let’s look at fixed costs first.

These fixed monthly expenses consist of things like HOA fees, insurance, taxes, and other exciting things.

For Example…

Let’s take a peek at some numbers based on a property we reviewed recently:

  1. Taxes. This property had $1,200/year in taxes. Divide that by 12 and you have $100/month. 
  2. Property Insurance. We’re going to look at $1,800/year or $150/month.
  3. Flood Insurance. This property didn’t have any HOA fees, but it did need flood insurance. That comes to $2,4000/year or $200/month.

In total, you have $450/month in expenses for this property before factoring in your mortgage payment.

How To Calculate Monthly Loan Payments

Once you know your fixed costs, there are a few other numbers to take into consideration before setting your rents. Once we know how much money is going out every month, we can figure out how much we need coming in.

The property in our example cost $250K and the investor paid a 20% down payment. 

  • Purchase Price = $250,000
  • Down Payment = 20%
  • 30-Year Fixed-Rate (8.5%) DSCR Loan = $200,000

The easiest way to calculate your monthly payments is to use a calculator designed for these numbers. We recommend using a site like calculator.net and selecting their amortization calculator

You can plug in the numbers, and it will do the work for you.

Once you plug in the numbers and hit calculate, you’ll see that your monthly loan payments are just under $1,538.

Updated Monthly Costs:

  • Fixed Costs = $450
  • Approximate Loan Payments = $1,538
  • Total = $1,988

Now that you know all of the money you’re paying each month, you know that to hit a DSCR ratio of 1, you’ll need to have rents of at least $1,988 in order to break even.

Using the DSCR Ratio to Set Rents

As we mentioned before, a DSCR ratio of 1 is fine – you won’t be losing money. But it’s not an optimal investment strategy. 

Lenders like to see you turning a profit, and you should too!

Returning to our above example, let’s say your outgoing expenses are $1,988. If you raise your rents by 25% (raising that DSCR ratio to 1.25 instead of 1), you’ll suddenly be making a 25% profit. 

Here’s how you get those numbers:

Breaking even on your real estate investing projects is great, but making money is the goal. Understanding how to calculate these numbers is a critical step towards successful investing

Check Out Our DSCR Calculator

To help you get an even clearer understanding of DSCRs, check out our DSCR calculator. It’s free to download and easy to use.

You’re also welcome to email us at Info@TheCashFlowCompany.com. We’re more than happy to answer questions and help you find the right deal.

We’re always looking for ways to help you succeed in your investment journey by giving you the knowledge and tools to win.

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How can you use the BRRRR method to get you in and out of a property with little-to-no money down?

Let’s start with a real scenario we encountered a few weeks ago. A client from Michigan called. He’s done flips before and even kept a few rentals, but he’s new to the BRRRR method. 

In the past, he’s always used partners or cash to fund his investing. However, this property needs more money.

He’s buying it for $200,000, putting approximately $22,000 of rehab into it, and we’ll estimate closing costs around $7,000. That’s a total of $229,000 for a pretty basic investment property. 

Where can this client find the money, and how can he leverage it to his advantage?

What is the BRRRR Method?

BiggerPockets launched the BRRRR acronym a few years ago. BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. This acronym outlines a helpful strategy for successful real estate investing. 

It centers around buying properties with built-in equity. After renovations, the investor can refinance therefore creating a sustainable cycle of investments. 

Can You Use a DSCR Loan to Begin the BRRRR Method?

The short answer is technically yes. However, since you don’t currently own the property, you can’t claim the equity in it just yet which makes it a not-so-great deal.

For our example client above, a DSCR loan will only cover up to 80% of the purchasing costs. This leaves 20% leftover — a large amount of cash that our client and a lot of newer investors simply don’t have.

Additionally, a DSCR loan won’t cover renovations or closing costs.

If you’re trying to exclusively use a DSCR for a BRRRR, you’re going to see the payments begin to add up really quickly.

A Better Plan

Instead of throwing a DSCR at the whole thing from the start, we suggest a different strategy of kickstarting your BRRRR cycle. 

1. Start with a bridge loan.

The BRRRR method is all about sustainable investing. How can you use other people’s money to keep cash flowing in and out of your projects?

This means beginning with a loan that’s going to cover those starting costs so you can get ownership and claim that equity!

A bridge loan is more flexible than a DSCR so you can cover the purchase, rehab, even the closing costs. 

2. Add the DSCR.

Once you’re actually starting to rent out the property, that’s the time for the DSCR. DSCRs have more restrictions anyways, so they’re most effective when used for renting.

The DSCR can pay off the bridge loan and you can refinance the property for an even better outcome. 

The Beauty of the BRRRR Method

By using this loan strategy with the BRRRR method, our client was able to come up with a plan that should easily generate over $1,000/month of positive cash flow for himself. 

And it all started with strategically using other people’s money to enter the BRRRR cycle. 

This is the beauty of real estate investing. It’s accessible and profitable, even for beginners. 

We’re Here For You

If you have any questions or want to discuss a project, reach out to us at Info@TheCashFlowCompany.com.

Please also check out the free tools on our website for downloads that can help set you up for success. Additionally, if you’re interested in the BRRRR method, make sure to explore our BRRRR roadmap

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Which rental loans are the BEST for your rental property?

There are three main loans that cover rental property loans: traditional, DSCR, and small bank loans.

Whenever we’re talking about rentals, we’re always going to come back to cash flow, and it’s important to find the best cash-flowing loan. 

If you’re deep in the real estate investing game, then you’ll probably utilize all three of these types of loans at some point. They all have their place. However, if you’re a newer investor, it can be tricky to figure out which loan is right for you.

We want to look at the pros and cons of each type of rental loan to help you understand which might be the best option to help your cash flow for a specific deal. 

Traditional Rental Loans

Pros of Traditional Loans

1. It’s a 30 Year Mortgage. This standardized timeline is reliable and consistent across most traditional loans.

2. No Prepay Penalty. Without a prepayment penalty, you can get out of the loan whenever you want. This is great if you anticipate a changing market and might want to sell early.

3. Lower Interest Rates. Between DSCR and traditional rental loans, you’re often looking at at least a whole point difference in the interest rates. While a single percentage might seem small, when you’re dealing with hundreds of thousands of dollars, the interest adds up very quickly. 

Interest rates affect everything from your cash flow to your credit score to your debt ratio. Depending on where you’re at financially, lower interest rates can be a huge point in favor of these traditional loans.

4. Home Hacking. With traditional rental loans, you’re actually able to do an owner-occupied loan. This allows you to live in one of the units you’re working on. Especially if you’re working on multiple units, you can move from one to another as needed.

Sometimes these owner-occupied loans have lower down payments and better rates, so they’re often worth looking into.

5. Same Rules Nationwide. Traditional loans are consistent across the country. No matter where you go, the guidelines are the same. This makes them predictable although they often have stricter guidelines than other loan types.

Cons of Traditional Loans

1. Property Limits. With traditional loans, you’re limited to 10 properties or 10 units. So while they do often have the best rates, you’re limited in how many properties they cover.

2. Need Income Proof and Good Credit. Not all loans need proof of income, but traditional loans certainly do. Your rates will also be limited by your credit score.

3. Cannot Close in an LLC. Unlike other loan options, traditional loans require you to close in your personal name because you cannot own the property when you’re going through a purchase or refinance in an LLC.

An LLC typically works to protect individuals from the financial effects of a business. However, because of the limits of traditional loans, you can’t use that protection in this scenario.

4. One Year Seasoning. You’re not allowed to refinance until after a full year has passed. This is especially important to consider if you’re doing a BRRRR and want to tap into some equity with a full refinance or purchase.

DSCR Rental Loans

DSCR stands for debt-service coverage ratio. You’ll often see these loans come up for anything from a single family home to a larger multi-unit property.

Pros of DSCR

1. Flexibility. While traditional loans find strength in their consistency, investors sometimes find themselves needed a lot more flexibility. That’s where DSCRs come in. 

DSCRs are significantly more flexible because lenders and investors can negotiate unique terms that fit a project’s specific needs.

2. Ease! The biggest benefit of DSCR is ease. It doesn’t matter if you’re employed, what your tax return says, or how much income you have flowing. DSCR lenders only care about the rental property and whether it has the potential to produce cash flow.

3. Close in an LLC. Another big thing in the real estate investor world is closing in an LLC. Unlike traditional bank loans, you can both buy and refinance in an LLC, so you’re protected all the way through.

4. Available in all 50 States. No matter where you are, you will be able to find available DSCR rental loans. However, the details might vary.

Each lender offering DSCRs have their own terms, guidelines, etc. This makes it incredibly important to shop around to make sure you find the right fit.

5. Unlimited Number of Properties. You will find so many options in the DSCR world. You can find loans for specific properties or do a blanket loan for $50 million that could cover as many units as you wanted.

Always make sure that the lender and loan are the right fit for you, and remember that there are a ton of options available!

Cons of DSCR

1. Prepayment Penalties. The number one downside of DSCR loans are the prepayment penalties. If you’re looking to get in and out of a property within the first three to five years, there’s a prepayment penalty unless you buy it out.

2. Higher Rates. Rates for DSCRs typically run anywhere from 1%-3% higher than traditional bank loans, depending on credit score, size of loan, etc.

3. Might Disappear or Change Quickly. DSCR loans are prone to change quickly. When shifts happen in the real estate market, they might even disappear for a brief time before showing up again.

While traditional bank loans are more slow-moving, DSCR moves quickly, and sometimes that can become an issue to real estate investors.

4. Can’t Home Hack. DSCR also does not allow you to live in any of the units you’re working on as you could with an owner-occupied traditional loan.

Local Banks for Rental Loans

Another option that fewer people consider is looking at loans from small, local banks. These local banks sometimes offer in-house products that can offer more flexible loans to people investing in their local area. 

Pros of Small Bank Loans

1. More Flexibility. Depending on your area, some local banks love real estate investors. If you shop around and find a small bank willing to invest, these loans often offer more flexibility than larger traditional loans. 

Because local banks are more likely to understand the area, unique properties that might seem strange to larger lenders might be more seriously considered by locals.

2. Decent Rates. Rates for local banks typically fall between traditional loans and the higher DSCR rates. However, you do keep more flexibility (the appeal of DSCR) for a lower rate.

3. No Prepay Penalties. Most local banks don’t have the extensive prepay penalties like DSCRs.

4. Good for Smaller Towns and Loans. Banks often want to invest in their local areas, and they’re often more willing to give out smaller loans for those areas as well. Of course, these banks still want to see good income and good credit.

Cons of Local Bank Loans

1. Each is Different. Every small bank makes their own rules. Because of this, its so important to shop around to find a bank that will offer you good rates for your specific project.

2. Lending Limits. Local banks also have lending limits. If you’re putting a portfolio together or doing multiple properties, you might hit up against that lending limit, and the bank might have to step away from offering you a loan.

3. Shop Around. As we already mentioned, one of the big negatives is you have to shop around. Small bank loans can also change like DSCR loans, so just because you talked to a bank at one point doesn’t exclude them from being considered again in the future.

4. Limited Areas/Regions. They also limit their areas and don’t want to go too far out of that market. Look for banks in the local area of your investment property.

5. Callable. Loans from small banks are callable. This means that, if they feel like the values have gone down, they could call the loan and make you pay it off or refinance it somewhere else. Neither traditional nor DSCR loans have this feature.

This gives small bank loans a bit more risk than other types of rental loans.

Which Loan is Right for Your Rental?

All three of these loans have their strengths and weaknesses. You can decide which is right for you based on your individual financial history and the needs of your project.

If you want help figuring out what loan is the best fit, we recommend checking out the tools on our website. We have our free DSCR calculator that can help you figure out your DSCR ratio. 

Our goal is to help you maximize the cash flow of your real estate investments. 

If you’re buying or refinancing a rental property and want to know if you’re getting the best terms, or if you have questions about comparing loan types, reach out to us at Info@TheCashFlowCompany.com.

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How has the changing landscape of real estate in 2023 affected requirements for DSCR loans? What are lenders looking at and how can you find the right deal for you?

The Power of Shopping Around

While this isn’t new, shopping around is very important in 2023. With a growing number of lenders loosening their requirements, finding a lender that specializes in projects like yours can make a big difference. 

If your project is unique or you’re dissatisfied with the rate you’re offered, reach out to mortgage lenders or brokers who have the power to offer something different. 

Requirements for 2023

Products change constantly, so it’s always a good idea to talk to professionals in your area, particularly when it comes to how DSCR lenders look at funding, financing limits, and credit:

Gift Funding Flexibility:

Lenders are trending towards having looser rules around gift money. Previously, it was better to have seasoned money in your account. Now, so long as the money is there for closing and it comes from your account, you’re usually set. That said, if you have any questions about gift funding, talk to your particular lender.

Property Ownership Limits:

A few lenders are also lifting their limits on how many properties you can finance. Previously, the majority of companies limited investors to 5-10 properties. Now, it’s fairly easy to find lenders without those restrictions.

Credit Influence:

Although DSCR loans don’t look at your income, they still look at credit. The better the credit score, the better the loan to value ratio. Also, the higher the DSCR calculation (rent ÷ income), the better the terms.

Standard Interest Only Options:

As always, there are interest only options. Depending on your project and the current market, these aren’t always the most helpful, but they are available. 

 

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What are Prepay Penalties?

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What are DSCR prepay penalties and how can you navigate them?

One of the normal things you’ll come across when looking at DSCR loans are prepay penalties. Understanding how they work (and the options you have) can help you make the best choices for your project.

What are DSCR Prepays?

If you’re working with a DSCR or a non-QM investor, you’re likely going to find lenders charging prepay penalties. 

Typically, if you want to exit the loan within a certain time period—often three to five years—they’ll charge an additional exit fee. This means that if you pay off your loan early, you could run into what’s called a hard prepay. 

Understanding the Cost of Prepay Penalties

Lenders don’t care about why you’re paying off your loan early. If you pay them in full, they’re going to charge the agreed upon fee (the prepay penalty). 

For example, if you have a $100K loan with a 3% prepay penalty, you would pay them 3% of the $100K on top of the principal and any interest or other fees owed.

While this can feel frustrating, these penalties actually allow these lending institutions to keep money flowing. Therefore, a prepay helps them keep interest rates stable by ensuring a consistent flow of capital.

Different Prepay Options for DSCR Loans

DSCR loans offer two standard prepay options: five-year or three-year periods. 

How does this connect to DSCR prepay penalties? 

During the initial five- or three-year period of your mortgage, you will be penalized for paying off your loan before the prepay period has elapsed. If you keep your loan past that benchmark, you will have no more prepay penalty. 

You typically will find two basic types of prepays:

  1. Straight Prepay: If you have a straight prepay, a lender may charge you a fixed percentage of the principal balance for each year, regardless of when you pay off the loan.

  2. Declining Prepay: A declining prepay is exactly what it sounds like. Each year, the prepay penalty decreases. For example, it may be 5% of the principal balance the first year, 4% the next, etc. until the prepay penalty disappears altogether.

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Is it possible in 2023 to find good DSCR loans for multi-units or larger portfolios?

If you’re looking for a DSCR loan for a large project such as a multi-unit or large portfolio, you’ve come to the right place.

DSCR loans have been around for a long time. In 2023, the real estate climate has experienced a few changes, and knowing how they relate to DSCR loans can help you get ahead of the game.

Changing Landscape for DSCR Loans

DSCR loans used to be most common for single-family or 1-4 unit properties. Now, in 2023 we’re seeing DSCR loans explode into multi-family, blanket loans for larger portfolios, and multi-units. 

With new options available, you need to know what to look for while remembering that all DSCR companies have specific niches. It’s important to find a lender who understands the particulars of your project.

Expanded Loans for Multi-Units

DSCR loans now cover a wider range of properties. It’s fairly easy to find options for large portfolios of more than $50 million, blanket loans for mixed-use properties, and larger multi-family units.

The range of these options provide greater flexibility when shopping around for DSCR lenders and exploring their requirements.

Flexible DSCR Loan Requirements

It’s now possible to find DSCR loan options for first time investors and investors who don’t own a primary residence. 

This opens up DSCR loan opportunities for investors who were previously more limited in their abilities to purchase investment properties.

Loans for Rural Properties and Condotels

If you’re looking to purchase rural properties, condotels, or other vacation rentals by owner (VRBO), you can now find DSCR loans for properties up to 20 acres. 

 

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What is the difference in DSCR loans: single-family vs multi-units.

A DSCR loan is a product that does not rely on income from the borrower or borrowing entity. The borrower could be an individual, an LLC, or a partnership. Regardless of who is borrowing, the lender does not require their income information.

Instead, a DSCR loan depends on the income (rent) from the property.

Traditionally, DSCR loans are used for single-family properties. However, there are products available for multi-family units as well. Here are some of the similarities and differences.

Ratio Requirements for a DSCR Loan

Debt service coverage ratio is the rent divided by the expenses of a property. If the DSCR is 1, that means the income perfectly covers the expenses, breaking even.

A DSCR loan for commercial property will likely require at least a 1.2 DSCR. This would mean your income is 120% more than your expenses.

For instance, if your mortgage, interest, taxes, and insurance add up to $1,000 per month, your rent must be $1,200 per month to have a DSCR of 1.2.

Differences Between DSCR Loans in Single-Family vs Multi-Units

There are some differences between a typical DSCR and a DSCR-style product for multi-family and commercial properties.

  • Loan size. The average DSCR loan is for single-family units, duplexes, and fourplexes, usually around $300k to $400k. A DSCR loan for commercial property, however, is a larger loan – typically anywhere between $1 million to $2 million.
  • LTV. For a typical DSCR loan, you could get an LTV of 80-85%. Commercial DSCR loans max out at 75%.
  • Terms. A DSCR loan for commercial property is amortized over 30 years or interest-only, like a traditional DSCR loan. They’re only fixed for a certain period, usually five, seven, or ten years.

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