Being a real estate investor often means getting non-traditional types of financing to buy properties. Whether you’re interested in a short-term or long-term loan, you should consider applying for a DSCR loan. This loan type allows you to avoid a lengthy approval process and high interest rates. Before you make an offer on your next real estate investment, let’s dive into DSCR loans to find out if they’re a good fit for you.

What Are DSCR Loans?

Most traditional loans focus on your income to figure out if you qualify. If your income is inconsistent or your credit score is low, gaining approval for a standard loan will be challenging. A DSCR loan may be more advantageous. These loans are available for residential properties that bring in income. If you want your next investment to be a single-family or multi-family property that you rent out to tenants, you could apply for a DSCR loan.

A debt-service coverage ratio (DSCR) loan is based entirely on the property’s cash flow. While standard loans require you to provide documentation in the form of tax returns, credit reports, and income verification, most DSCR loans don’t ask for these documents. All you need to do is calculate the DSCR ratio to estimate how much income the property will produce. The ratio tells lenders if you’ll be able to use your rental income to cover the monthly mortgage payments.

How to Calculate DSCR

When you’re trying to build a strong real estate portfolio that’s filled with successful investments, you’ll need to make the occasional calculation. The DSCR formula is straightforward. Simply divide the property’s annual gross rental income by its debt obligations.

You can determine the gross rental income by adding up the estimated monthly payments you expect to get from future tenants. Since you don’t yet own the property, you can set the appropriate monthly rental amount by looking at comparable properties near the one you’re interested in. Look at the rent prices for single-family homes that have similar features and square footage.

To make the calculation, add up your annual debt, including everything from HOA payments and the loan principal to taxes and insurance. You can now divide the gross rental income by your annual debt to find the ratio.

When >applying for a DSCR loan, you’ll quickly discover that every lender has its own requirements for the minimum ratio. A ratio of 1.0 means that you’re earning enough income each month to pay your debt obligations. However, lenders often want a DSCR of at least 1.2-1.25.

Qualifying for a DSCR Loan

DSCR Loans often have less strict requirements than traditional mortgages. To qualify, you’ll still need to meet all the criteria that the lender requires. Specific criteria can vary from lender to lender. To qualify for a DSCR loan, the general guidelines you’ll need to meet include the following:

• DSCR ratio that’s at least 1.0-1.2
• A max loan amount of around $2 million
• A minimum loan amount of around $100,000
• A credit score of 620 or more

Credit scores aren’t as important to DSCR lenders as they are with traditional banks. However, you may still need to show that you have a decent credit score and history. If your credit isn’t in good shape, start making your bill payments on time. It’s also a good idea to slowly pay off any outstanding debt you have. Your credit score should begin to improve in no time.

The requirements listed above are more flexible than the ones that come with standard mortgages. For example, the minimum and maximum amounts for DSCR loans can be higher or lower. Regardless of how expensive the property is, you should focus on showing the lender that you can make the monthly mortgage payment with the income you bring in.

While many investors use DSCR Loans for single-family residential units, they’re also available for multi-unit structures. However, some lenders still restrict their DSCR loans to buildings that contain a max of four units.

To make sure the loan amount is right, lenders look at the loan-to-value (LTV) ratio. Most lenders require a 20% down payment, which is the same as an 80% LTV ratio. They’ll also check the appraisal report to make sure the property’s value is correct. They don’t want to be in a situation where they loan an amount that’s higher than the property’s true worth.

Benefits and Drawbacks of Applying for a DSCR Loan

DSCR Loans offer many advantages that you simply can’t get from standard mortgages. While these loans are designed specifically for investors, they’re not without drawbacks. The main reasons why you should consider applying for a DSCR loan include the following:

• No limit to the number of loans you can apply for
• DSCR loans have fast processing times
• Jumbo loans are available for multi-family properties
• You don’t need to provide proof of income, which means that the loan is easier to qualify for
• The application process doesn’t require nearly as much documentation

You may even be able to customize your mortgage payments to make sure you don’t need to pay too much every month. The main issue with DSCR loans is that they come with high down payment requirements. You’ll need to pay at least 20% of the property’s price to get approved for one of these loans. A few other drawbacks include the following:

• Some DSCR lenders maintain high credit score requirements
• The loan might come with stiff prepayment penalties
• You can only use this loan on an income-generating property
• Not all properties will meet the DSCR ratio requirement of at least 1.0

If you don’t meet some of the strict requirements that conventional lenders often have, A DSCR loan may be the exact thing you’re looking for. It gives you the money you need to buy a rental property without asking you to verify income or show a high credit score. The documentation that DSCR lenders need for approval is far more reasonable. If you’d like to use a DSCR loan for your next investment property, get in touch with us today.