What are Debt Service Coverage Ratio (DSCR) Loans?
Debt Service Coverage Ratio (DSCR) loans are a specialized loan product for real estate investors that focus on rental income rather than the borrower’s personal income. This makes them a fantastic solution for investors seeking to purchase rental properties, as they require little to no income or employment verification.
What Does DSCR Measure?
Unlike conventional loans, which assess the creditworthiness of the real estate investor, a Michigan DSCR loan analyzes how well rental properties cover their own debts. This is identified by the Debt Service Coverage Ratio, which divides the rental property's net operating income by its debt service.
Net Operating Income (NOI) vs. Debt Service Obligations
A property’s cash flow is assessed by subtracting the operating expenses from its monthly rental income. Operating expenses include things like property taxes, property management, loan payments, repair and maintenance, and insurance. This will identify how much income the investment property makes per month.
Debt service examines the costs associated with owning real estate rather than the business aspects. These include loan principal, interest payments, property taxes, insurance, and HOA fees.
Determining Your Property's Income-Generating Potential
To calculate the income for investment properties, divide the net operating income by the debt service to get a ratio. Lower DSCR ratios mean that your property’s rental income is too low, while a negative ratio signifies that you’re operating at a loss.
To get DSCR loans, real estate investors should strive for a ratio of 1.25 or higher. Some DSCR lenders will accept a ratio of 1, meaning you’re breaking even, but they will expect a higher down payment for any property making below the typical DSCR threshold of 1.25.
DSCR Loans
Michigan
Michigan DSCR loans are tailor-made for real estate investors, allowing you to borrow based on monthly rental income rather than your own income. These low-documentation loans have competitive interest rates, flexible qualification requirements, and higher loan limits.
If you’re ready to pursue DSCR loans in Michigan, contact Pride Lending, the first LGBTQ-focused brokerage firm in the United States!
Why Choose DSCR Loans in Michigan?
Specialized real estate investment loans are typically a better choice for income-generating properties than conventional mortgage products, which are geared toward owner-occupied properties.
Their benefits include low documentation requirements, faster approval and closing, higher loan limits, and more flexible underwriting requirements, which are very helpful for self-employed individuals.
Focus on Property Cash Flow, Not Personal Income
Many investors struggle to access conventional loan products because of the personal income verification necessary, such as personal tax returns and pay stubs. As their primary income may come from rental property, they may not have the documentation required for conventional underwriting.
While most lenders will require a borrower’s credit score to approve a DSCR loan, their primary interest will be the income potential of the subject property, making it easier to qualify.
Easier Qualification for Investors With Multiple Properties
Another reason that real estate investors love DSCR loans is that they make it easier to create a strong presence in the Michigan real estate market by packaging multiple properties in the same loan. Some lenders will allow you to roll up to 10 properties into the same mortgage, significantly enhancing your ability to grow your real estate portfolio.
Potential for Higher Loan Amounts
DSCR loans have a higher maximum loan amount than other loan products because they do not need to meet the stipulations set by Fannie Mae and Freddie Mac for sale on the secondary mortgage market. This can hamper your ability to buy large commercial properties, limiting the potential income generated.
Compared to other loans, DSCR loans can be very generous. Depending on the lender, you may be approved for a $2 million loan in Michigan, and some will extend even more to those with a great credit profile.
Flexible Underwriting Guidelines
DSCR loans are non-QM loans, meaning that they do not have to meet the same underwriting requirements as conventional mortgages. As such, loan officers have more flexibility in the documentation they require, such as the minimum credit score.
Quicker Closing Times Compared to Traditional Loans
Thanks to the lower documentation requirements, real estate investors can close on their subject properties faster than with traditional loan options. The time to close may be as short as a few weeks rather than several months.
DSCR Loan Requirements in Michigan
Michigan DSCR eligibility requirements focus on the viability of the property, though some investigation into the investor is conducted, including minimum credit requirements. To improve your chances of approval, consider these key factors before applying.
Minimum DSCR Ratio
Most lenders will accept a minimum DSCR ratio of 1.25, meaning that your property is making at least 1.25 times your mortgage. Ensure that your property is at or above the market rent to help boost your ratio.
Property Type
Types of property you can buy include residential rental property like long-term rentals, short-term rentals, and vacation rentals. Some lenders will also accept commercial real estate like restaurants and hotels or industrial properties like factories.
Down Payment Requirements
The minimum down payment for a DSCR loan is typically 20%. These higher down payments help protect the lender in case you default, so ensure that you save up before applying to meet this requirement.
Appraisal and Inspection Requirements
With traditional loans for owner-occupied homes, the lender will typically request one appraisal and inspection, but real estate investors should expect to have at least two appraisals when receiving Michigan DSCR loans.
These additional assessments are to gauge the potential rental income, ensure that the property is ready for tenants, and make sure that the purchase price matches the market value.
Understanding DSCR Calculation
Unlike the typical loan program, DSCR loans rely primarily on the Debt Service Coverage Ratio, which is the net operating income divided by the annual debt service.
Net Operating Income and Total Debt Service
Net operating income assesses your rental’s cash flow once all business expenses have been accounted for. This includes property repairs, taxes, maintenance, and security services.
Conversely, debt service is the expenses associated with owning the property itself, such as the mortgage, property taxes, homeowners’ insurance, and homeowners association dues.
For example, assume that your rental income is $150,000 annually and your operating expenses are $20,000. This would give you an NOI of $130,000.
If your debt service was $104,000 per year, you would divide your NOI by your debt service to get a ratio of 1.25, which would qualify you for a DSCR loan.
Who Benefits From Michigan DSCR Loans?
DSCR loans are a great alternative for those who rely primarily on rental income because they have competitive interest rates and are easy to qualify for.
Real Estate Investors
DSCR loans are a better option for long-term investments than hard money loans, which have high interest rates and short loan terms.
Self-Employed Borrowers
Self-employed borrowers often find it difficult to qualify for conventional loan options because of the strict underwriting requirements, which demand pay stubs and W2s. Non-QM loans like DSCR loans have more flexible underwriting and can use other income verification tools, like rent agreements and market rents, to approve borrowers.
Borrowers with Multiple Properties
Real estate investors seeking to expand their portfolio will appreciate that multiple investment properties can be packaged in the same loan, helping to keep payments manageable by enjoying the same interest rate and one monthly payment.
The DSCR Loan Process
A mortgage broker from Pride Lending will guide you through each step of acquiring DSCR loans, which includes these steps.
Find a Lender - DSCR loans are specialized products available only from certain companies. We’ll help you assess your options by examining the company’s credibility, guidelines, and any DSCR loan-specific rules, like prepayment penalties.
Identify Your Market – With DSCR loans, much of the approval process hinges on the property itself, so it’s a good idea to understand the typical rental income of the given market first.
Get Pre-Approved - Just as with other loan products, you will submit an application; however, as DSCR loans are focused on investment, the pre-approval process will focus on checking your credit score and assets.
Shop for Property - Working with a real estate agent familiar with commercial properties will help you find a property with high income potential.
Calculate DSCR – You and the lender will ensure that the property’s ratio meets the requirements; typically, this means a DSCR of 1.25 or higher.
Loan Application - During this step, the lender will order several appraisals and inspections of the property to ensure that it has a high enough DSCR.
Underwriting – As with traditional loans, an underwriter will double-check that all the information is correct and that the loan represents an acceptable risk to the company.
Approval and Close – Once you’ve been approved, you’ll sign paperwork, review the loan disclosure agreement, and take control of your brand-new investment property.
Why Choose Pride Lending for Your Michigan DSCR Loan?
Pride Lending is the first mortgage company dedicated to helping LGBTQ homeowners, real estate investors, and self-employed borrowers achieve property ownership. We’ll work with you every step of the way, helping you find competitive interest rates and lenders with a great track record in DSCR loans.
Our team has years of experience with the intricacies of the Michigan real estate market. Investors will receive helpful advice, prompt answers to their questions, and, above all, a fierce commitment to serving underrepresented communities.