What is a Debt Service Coverage Ratio (DSCR) Loan?
A Debt Service Coverage Ratio loan is one metric used by lenders to monitor the financial performance of rental properties and determine the maximum loan amount that can be granted.
A DSCR loan evaluates the borrower’s ability to repay debt by assessing their net operating income and expenses. By evaluating the amount of net cash flow of a business, lenders can determine the amount of income that borrowers can put towards a mortgage.
A Debt Service Coverage Ratio loan is used by real estate investors to expand their portfolio by obtaining one or even multiple new properties at a time. A DSCR determines the maximum loan amount that a borrower can obtain for a new loan or to refinance an existing mortgage.
Part of the underwriting process to grant a loan is to calculate the DSCR. A larger DSCR ratio means that there is more NOI that can be applied to the debt, thus granting a larger loan. DSCR ratios can vary year-to-year and the average interest rates vary as well. Once a loan is established, borrowers will pay this fixed rate for the duration of the loan, unless they decide to refinance.
How Does DSCR Lending Work?
A DSCR lender uses the DSCR ratio to determine the financial well-being of a company. This allows lenders to determine whether a company’s debt obligations in comparison to their operating income indicates their ability to sustain mortgage payments.
A DSCR ratio states the net operating income of a company with consideration of all the debt obligations a company has assumed within a year, including lease payments and interest. Different DSCR metrics may be targeted depending on the individual lenders and partners that evaluate a company. Additionally, the history of a company and industry standards relating to this company’s niche will be considered.
DSCR terms are typically included in loan agreements so that both lenders and borrowers have a clear idea of the financial state of a company. DSCR ratios can be calculated over a period of time in order to understand the specific financial trends of a company. DSCR ratios can also be used to compare operational efficiency rates across multiple related companies.
DSCR ratios serve as a comprehensive analysis of a company’s financial state by considering an array of specific financial aspects, such as principal repayments.
How to Get a DSCR Loan
Obtaining a DSCR loan is a relatively simple process. In order to determine whether or not you qualify for a DSCR loan, view the eligibility and loan requirements below.
Eligibility for a DSCR Loan
Eligibility for a DSCR loan is determined by your credit score. Some lenders require a minimum of 640 for a DSCR loan while other companies may require a minimum credit score of 680.
Along with your credit score, the financial health of your company will also be evaluated to determine whether or not you are eligible for a DSCR loan. This is done by calculating the company’s net operating income divided by the total debt service to determine whether or not you can afford the minimum mortgage.
Additionally, lenders will assess whether or not you have the funds for a down payment. A DSCR loan typically requires a down payment of at least 20%.
DSCR Loan Requirements
Coverage Ratio
To qualify for a DSCR loan, a property’s rental revenue must meet or surpass the lender’s coverage ratio criteria. While this varies, it is calculated as monthly rental income divided by the mortgage payment and can range from 1.0x to 1.5x on average. If you put more than 30% down, the coverage ratio could potentially be reduced.
Eligible Properties
DSCR mortgage loans allow individuals to invest in a variety of properties that may not be obtained with other loans, such as properties with more than four units. Under a DSCR loan, an LLC can also own properties. Additionally, there is no limit on the total number of properties that can be financed with a DSCR loan. This makes the DSCR loan perfect for those who are looking to rapidly expand their real estate portfolio.
Refinancing Options
Many DSCR programs provide ample opportunities for refinancing. You may be able to withdraw more money with this loan than a conventional loan. This is beneficial to real estate investors because if you suddenly encounter the need for emergency funds, you can look into refinancing your property.
Loan to Value Ratio
A DSCR lender will typically require a minimum 20% down payment, or LTV ratio of 80% for a DSCR loan. Some lenders may offer lower downpayments, but these may be accompanied by higher interest rates.
Maximum Loan Amount
DSCR loan requirements allow for a higher maximum loan amount than some other lending programs. A maximum loan amount can vary based on the lender but typically falls somewhere in the millions, making DSCR loan programs ideal for high-value investments.
Prepayment Penalty
Some DSCR loans may have a prepayment penalty. Evaluate the terms of your loan to see if there are any pre-payment fees associated with your loan that you should be aware of.
DSCR Loan Qualifications
Credit Score
A DSCR lender typically requires a credit score of at least 640-680. This can vary based on individual lenders, but you will rarely find a DSCR lender that accepts a credit score lower than 640.
The flexibility of this loan program and opportunities it provides for investment means that most lenders will only grant this loan for those who have proven themselves to be in good financial standing.
Foreign investors can qualify for DSCR loans without established credit, given that they can prove their financial eligibility otherwise.
Coverage Ratio
Unlike some lenders that consider your personal debt to income ratio, your employment, or income, DSCR loan qualifications use a coverage ratio to determine eligibility instead. The coverage ratio refers to a company’s net operating income divided by the total debt service.
Is it Hard to Get a DSCR Loan?
It is generally not hard to get a DSCR loan. As long as your company is in good financial standing, you have the funds for a down payment, and you have the minimum required credit score, it is very likely that you will be able to obtain a DSCR loan.
How to Calculate DSCR
A DSCR in real estate is calculated by dividing the net operating income by the total debt service of a company.
The net operating income is determined by subtracting operating expenses from the revenue.
The total debt service includes all current debt obligations such as interest, sinking fund, principal, and lease payments.
DSCR = Net Operating Income / Total Debt Service
Why is DSCR Important ?
DSCR helps lenders negotiate loan contracts that are safe and reasonable for all parties. Lenders can manage their risks by considering the DSCR of a company as part of their loan contract.
If a company’s DSCR drops below 1.25, they could be at risk of defaulting on their loan so lenders will generally be looking for companies to stay above this.
Additionally, DSCRs offer a clear way for a company and its investors to assess and monitor their financial state.
What is a “Good” Debt Service Coverage Ratio?
What’s considered a “good” DSCR may vary based on a company’s individual age, industry, and competition. The stakes may be lower for a newer, smaller company. However, a “good” DSCR will generally be above 1.25. If it is below 1.00, the company may be at financial risk.
DSCR Loan Down Payment Requirements
Borrowers are required to put down a 20% minimum down payment to obtain a DSCR loan. Putting down a higher amount may occasionally grant lower interest rates on payments. However, it is extremely rare for a DSCR loan it to be granted without a down payment of 20%.
DSCR Loan Interest Rates
What Are the Interest Rates for DSCR?
DSCR loan interest rates currently average between 7.20% and 8.57%. DSCR loan interest rates can vary drastically from year to year. DSCR loans are on a fixed rate, so once a contract is in place the interest rate will not change. However, borrowers can refinance their property to take advantage of a better rate.
Are DSCR Loan Rates High?
Currently, average interest rates are higher in 2022 than they were last year (avg 7.72% compared to 4% in 2021).
Are DSCR Loans on a Fixed Rate?
Yes, but there are ample opportunities for refinancing compared to other loan programs.
DSCR Loan Benefits
There are many benefits to obtaining a DSCR loan. Personal income is not accounted for, so this can be beneficial to those who have savings or sufficient company income but don’t have sufficient personal income.
One of the biggest benefits of a DSCR loan is that an individual can obtain multiple loans for multiple properties at a time. This is perfect for those who wish to expand their real estate portfolio quickly within a short amount of time.
It’s also easy to take out as much cash as you’d like, whenever you like to do so, due to the flexible refinancing possibilities of a DSCR loan. This can be extremely helpful in emergency situations.
The application and closure process for a DSCR loan is relatively fast and simple compared to some lending programs. Overall, the DSCR loan program is great for new and experienced real estate investors alike.
Are DSCR Loans Right For Me?
The best DSCR lenders provide opportunities for loans that otherwise may not be obtained. If you’re looking for a loan program that considers your company income instead of your personal income, the DSCR loan is certainly worth considering.
Additionally, the DSCR loan makes it easy for one to expand their real estate portfolio rapidly by obtaining multiple loans. The DSCR loan also offers flexibility for those who wish to refinance or cash out on their property on their own terms.
Whether you’re brand new to real estate investing or an experienced investor, the DSCR loan program can certainly help you advance your real estate portfolio as quickly as possible.
