DSCR Loans
Achieve your investment dreams with Debt Service Coverage Ratio Loans!
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Investing is a powerful way for anyone to develop a strong income stream, and it is especially important for those who have been historically closed out of real estate investments.
Serving underrepresented communities is a win-win for everyone: the management consulting company McKinsey & Co found that entrepreneurs with greater ethnic and gender diversity produced 30% more in returns than a white male founder. However, about 51% of Black and 49% of Hispanic US adults don’t own any investments, which is significantly lower than their peers.
42% of LGBTQ+ potential investors list a lack of capital as a reason that they cannot start or expand their operations, proving that funding is an essential element of improving equality for these marginalized groups.
Thankfully, there are specialized mortgage products that can help you afford to join the millions of real estate investors who are taking charge of their finances through real estate. DSCR loans rely on the cash flow of the investment property rather than your personal income, making them a perfect option for those seeking to buy rental property with minimal income.
What are Debt Service Coverage Ratio (DSCR) Loans?
Unlike traditional loans, Debt Service Coverage Ratio (DSCR) loans utilize a property’s cash flow to determine eligibility based on the rental’s ability to cover its debt obligations through rental income. This means that it identifies whether the property generates sufficient income to finance itself without you investing personal funds.
While you may still have to provide financial information as part of the loan approval process, most of the focus will be on appraising the investment property and determining market rents rather than analysis of your credit score and income.
This focus on property income makes DSCR loans a better option than conventional mortgages for well-performing real estate investments with consistent cash flow. Additionally, a DSCR loan program will often allow you to roll multiple investment properties into one loan, allowing rental property investors to expand their real estate portfolio faster than with other loan options.
Estimate Your Monthly Payments
DSCR loans focus on the Debt Service Coverage Ratio, which is the property’s net operating income divided by the annual debt service. This includes PITIA: principal on your monthly mortgage payments, total interest payments, property taxes, homeowners’ insurance, and association dues.
A Debt Service Coverage Ratio of 1 means that your property is breaking even: it’s neither losing money nor making any.
If you have a ratio of more than 1, the real estate property has a positive cash flow, while a ratio of less than 1 signifies a negative cash flow.
Most lenders want to see that the property can generate rental income rather than simply satisfying its annual debt payments. If you have rental properties that are only breaking even, then the lender may either ask you to make a higher down payment or show a plan for generating income after you purchase the property.
Net Operating Income (NOI) vs. Debt Service Obligations
Net operating income is the company’s cash flow after subtracting all expenses from the gross rental income.
This means that you will calculate the property’s income and then remove things like monthly loan payments, utilities, landscaping, property taxes, homeowner’s association dues, and security. Calculating NOI will tell you if you have any money left over after you pay off the property’s expenses every month.
The debts in DSCR do not include all the operating expenses subtracted from net operating income; it only focuses on the debt obligations related to your mortgage loan, not the fixed or variable operating expenses such as repairs.
The debt service is generally represented by the acronym PITIA, which is the principal and interest on your mortgage payment, the property taxes, homeowners’ insurance, and any homeowners’ association dues you may have.
Determining Your Property's Income-Generating Potential
Now that you have identified the NOI and the debt service, you can calculate the Debt Service Coverage Ratio (DSCR) and determine whether your rental properties generate income sufficient to get a loan. You’ll divide NOI by the total debts, generating a ratio.
Anything above 1 is a good sign that your property adequately covers its debts, but you generally need a ratio of 1.25 or better to secure a DSCR loan.
Many real estate investors calculate their DSCR every year by looking at the annual NOI and annual mortgage debt and then comparing them to last year’s ratio. This helps them identify whether it’s possible to improve the property’s ability to satisfy its debts by raising rents or whether paying down the principal has improved their cash flow.
Why Choose DSCR Loans?
DSCR loans are an excellent way for a real estate investor to separate their personal assets from their business expenses, helping to protect their personal credit score. Additionally, DSCR loans typically have a faster approval process that can help you stay competitive in hot markets.
Focus on Property Cash Flow, Not Personal Income
DSCR loan requirements are focused on the Debt Service Coverage Ratio of the investment property rather than the borrower’s ability to repay debts out of their personal income. This is incredibly important for marginalized individuals, as about 57% of LGBTQ+ individuals make less than $50,000 a year, compared with 36% of adults overall. Black women are paid one-third less than their white male coworkers doing the same work, and Hispanic women make only 63% what a white man would. '
A lower income makes it difficult to develop a real estate portfolio when using an income-based loan like a conventional mortgage, but DSCR loans are different, making them perfect for BIPOC and LGBTQ+ borrowers.
While many lenders require a credit check and some details about your personal finances, they are more flexible about these requirements, especially if you are choosing high-performing real estate with a strong DSCR ratio.
You may not have to provide tax returns, pay stubs, or other details, which shortens the qualification process.
Additionally, as you can take a DSCR loan under a company name, you can protect your personal assets should your investment property run into issues.
Easier Qualification for Investors With Multiple Properties
One of the most beneficial aspects of DSCR loans is that you can roll multiple properties into one DSCR loan rather than taking out a different mortgage for each property.
Not only does this streamline your mortgage payments, but it also means that you can expand your portfolio faster, as you won’t need to go through the approval process for each separate loan.
Some DSCR loan companies will allow real estate investors to purchase up to 10 properties with the same mortgage, which allows you to build your portfolio much faster. Your DSCR loan approval will be based on the collective DSCR ratio of all the investment properties included in the loan, meaning that you can take a risk on one rental property as long as the others are proven winners.
Potential for Higher Loan Amounts
A typical conventional mortgage is bound by the Federal Housing and Finance Agency conforming loan limits, which may not cover the property value for even one home. However, DSCR lenders are willing to go higher than this, recognizing that you will need more funds to purchase more than one investment property at a time.
As these are private lenders, each will set its own maximum and minimum loan amount. Depending on the stipulations and the property income potential, you can take out a loan as small as $75,000 or as high as $2 million.
Flexible Underwriting Guidelines
DSCR loans are provided by private lenders, who are given more freedom in qualification than loans purchased by Fannie Mae or Freddie Mac.
With a DSCR loan, you may be able to find lenders who don’t require personal finance documentation, or they may be willing to lend to those with a low credit score as long as they provide higher than the minimum down payment.
There is greater flexibility and negotiation with a DSCR loan, proving useful to those who may not be able to access loans otherwise.
Quicker Closing Times Compared to Traditional Loans
Because the primary focus is on the qualifications of the investment property rather than your credit history, closing times are much faster for a DSCR loan than for a conventional mortgage loan.
The majority of the underwriting will be a thorough investigation of the property’s rental history, its market value, and the market rents in the area, with only a cursory check of your personal income. As such, you can close in a fraction of the time compared to any other mortgage loan.
The quick close times prove very helpful in a hot market where investment properties are in high demand, as even a few days’ delay may mean you miss out on the best rental homes.
DSCR Loan Requirements
DSCR loans are more commonly provided to real estate investors who have proven experience with existing properties, though a loan officer from our team can work to find options for you if you are a first-time investor.
To avoid DSCR loan surprises, it’s important that you understand all the stipulations associated with this specialized loan product, including the necessary ratios, down payments, and appraisal requirements.
Minimum DSCR Ratio
Generally, DSCR loan lenders want to see a ratio of 1.25 or higher. This means that your property produces 1.25 times its debt obligations after deducting all operating expenses.
It might be possible to secure a DSCR loan with a ratio of 1 or higher, but you may have to provide a higher down payment than if the ratio were better.
Thankfully, finding ways to improve your ratio is possible to boost your chances of getting approved for a DSCR loan. Common ways include checking the market rents in the area and raising the rent accordingly or making improvements to the investment property so that it can command a better rent rate.
Property Type
As DSCR loans are meant for investors, only real estate investment properties are eligible for this type of mortgage. That includes single-family rental homes, duplexes, triplexes, and vacation rentals.
You may be able to secure a DSCR loan on a duplex that you will use as both a rental and a primary residence, but if this is the only property that you are buying, another loan product may be a better option.
DSCR loans may also be used for commercial properties, such as restaurants, office buildings, apartment complexes, and hotels. Some lenders provide funding for more specialized properties, like warehouses and industrial facilities.
A loan officer from Pride Lending will explore your investment goals and match you to the right mortgage product for your specific needs, whether that is a DSCR loan or an FHA loan.
Down Payment Requirements
Generally, the loan-to-value ratio for a DSCR loan can be no higher than 80%. That means that you will have to provide at least a 20% down payment, though some lenders may expect up to 25% depending on the rental potential of your target property.
It’s sometimes possible to find a DSCR loan with only a 10% down payment, but these may have higher interest rates or other requirements. We’ll assist you in finding a good product that matches your financial circumstances and investment goals.
Appraisal and Inspection Requirements
As with other loans, you will need to undergo an appraisal before being approved for a DSCR loan; however, investment properties often require more than one appraisal.
These products are riskier for lenders because they cannot be sold on the secondary mortgage market, meaning that lenders want to be entirely certain that they are not lending more than is necessary.
While an inspection is often optional for a residential property, your lender may require it before they will approve you for financing on a rental home. The inspection process will be more thorough, as lenders want to uncover any potential issues that will damage your ability to generate income. You may be required to fix any issues before you can receive funding.
Understanding DSCR Calculation
DSCR loans rely on the ratio between your NOI and your debts, which is called the Debt Service Coverage Ratio. This assesses whether your property is making enough to cover its own debts without your personal income.
Net Operating Income and Total Debt Service
NOI refers to how much money is left over from your property’s income after removing all the operating costs, such as the mortgage, utilities, landscaping, security, and upkeep.
Debt service is focused on the costs of keeping the property, such as mortgage principal, interest, taxes, insurance, and association dues. You’ll divide the NOI by the debt service to get a ratio; negative means your property isn’t covering its own debts, while a ratio above 1 means it is covering its debts and making an income.
It’s best to look at this annually rather than monthly because your NOI may dip in a given month due to things like a washing machine breaking or having to pay extra for snow removal.
Debt services are typically fixed, annual debts, such as property taxes or homeowners' insurance premiums. Taking the average of your monthly NOI and dividing it by all the costs of covering your property’s expenses will give you a clearer picture.
For example, let’s assume that your annual gross rental income is $31,200, your operating expenses are $12,480, and your total debt service is $14,976. This would give you a NOI of $18,720.
After dividing $18,720 by $14,976, we get a ratio of 1.25, which is exactly what lenders will expect from a borrower.
Who Benefits From DSCR Loans?
DSCR loans are an excellent solution for purchasing income-generating property, as they have a streamlined application process and require little personal information from applicants.
They are most suitable for these three groups of borrowers: investors, self-employed borrowers, and those purchasing multiple properties at once.
Real Estate Investors
DSCR loans make it easier for investors to purchase rental property without resorting to a conventional mortgage, which requires intensive investigation into their own credit history.
If most of their income comes from rental properties, they may struggle to get approved, even if they have ample funds to afford their new investment. With a DSCR loan, the property’s rental income is the most important qualification, which makes it easier for seasoned investors to qualify.
DSCR loans work similarly to any other mortgage: they will have a 15-year or 30-year term. This makes them a better option than a hard money loan for those who intend to rent out their property for the long term. Hard money loans also don’t require information like tax returns, but they have a much shorter repayment period.
Generally, you will make interest-only payments for one to two years, then pay the rest of the balance back at the end of the loan. Because of this short time period, it’s easy to default on hard money loans, which can imperil your investment. DSCR loans allow you to pay back over a much longer period, making them a safer option.
Self-Employed Borrowers
Self-employed borrowers, such as those who rely on rental income and gig work, may find it very hard to get a traditional loan because they won’t have the necessary documentation, like a W2 or pay stubs. This can freeze them out of the investment market and make it hard for them to improve their income.
Thankfully, DSCR loans are more flexible, as they require little income documentation on the borrower’s behalf. The primary focus is on whether the property itself can cover its debts, as well as a minimum credit score from the borrower. Many times, all you will need to provide is your credit score and identity verification.
If you’re a freelancer with an LLC, you can take out a DSCR loan under a corporate name, further helping to keep your business and personal expenses separate. This can ease the process of completing your income taxes each year while also protecting your own assets from seizure should something go awry with one of your investments.
Borrowers with Multiple Properties
DSCR loans enable investors to roll multiple properties into the same loan, which makes it much easier to afford a mortgage. Most loans will only allow you to purchase up to four units with one mortgage, but depending on the specific lender you work with, you may be able to put as many as 10 properties under one loan.
Instead of worrying about different interest rates and loan terms, you’ll have the same mortgage for all your properties, streamlining your expenses and ensuring you stay on track.
As an added benefit, DSCR loans also allow for cash-out refinances, often with a much shorter seasoning period than for other loans. With a cash-out refinance, you can put a down payment on a new property or make repairs to your current investments, improving their value and commanding a higher rental income.
It’s also possible to refinance a DSCR loan to incorporate another property into the package, which also eases the process of adding to your portfolio.
The DSCR Loan Process
Applying for DSCR loans is much easier than for other products because there is less paperwork involved. As such, you can go from pre approval to closing faster than if you chose a conventional or government-backed loan. Here are the simple steps necessary to begin investing in your dream property.
Check the Requirements
Before you apply, you should perform due diligence and ensure that you’re eligible. While DSCR products don’t rely heavily on your credit score, having a good score will improve your chances of approval. You’ll also want to ensure that you have enough upfront collateral and a strong business plan in place.
Contact Pride Lending
Our team at Pride Lending will help you find the perfect provider for DSCR loans based on your specific needs and the property you would like to buy.
Submit Your Details
Pride Lending wants to ease the process as much as possible, which is why we have an all-online application process for pre approval. Provide your details such as your credit score, income, and financial details, and we’ll work with you to determine your pre approval amount.
Get Pre Approved and Pick a Property
Pre Approval is not always necessary, but it can help you stay competitive in a hot market. You should also assess the market and find a well-performing property.
Working with a realtor familiar with the local investment market can ensure that you select one with great potential based on local income, market demographics, and any future changes to the local business environment.
Submit an Offer
If you’ve decided that this will be a good investment, you and your realtor will decide on a competitive offer together. We’re here for you throughout this process and would be happy to help you with any budgetary questions you might have.
Calculate the DSCR
You will use a rent schedule to prove the property's monthly income based on its fair rental value.
If the property has a rental history, you’ll show old lease agreements, while if you are converting a property into a rental, you will use evidence of the market rents in the area.
Fill Out an Application—On the application, you’ll provide some basic details about yourself,
Fill Out an Application
On the application, you’ll provide some basic details about yourself, including consent to check your credit score.
You will also offer details about the target property, which will be used to assess its income potential. The lender will also calculate the DSCR, which is the primary approval component.
Offer Acceptance
The seller will decide whether or not they feel that your offer is fair. If they accept it, then you will sign a sales contract, and the mortgage will now undergo underwriting.
Inspection
Your lender will likely require that the home be inspected to ensure there are no serious issues that may imperil the investment. This also can uncover issues that may lead to a cancellation of the sale.
Conditions
If you’re happy with the inspection report, then it’s time to double-check the purchase contract. We’ll walk you through it and ensure that the conditions are amenable.
Undergo Underwriting
Underwriting is much faster for DSCR loans than for other products because there’s no focus on the borrower’s ability to repay the loan themselves. Depending on the documentation provided, you may be able to close in under a month.
Get an Appraisal
Before you can be approved for DSCR loans, the property must be appraised, sometimes twice. This assures the lender that they are not overpaying for the property in question, especially because these loans are riskier for lenders.
Clear to Close
Once the appraisal is completed and the underwriting has gone through your paperwork with a fine-toothed comb, then you’re clear to close. We will schedule the closing date with you, and the title company will send the wiring information so that you can transfer your money.
Close
As with other loans, you will need to pay your down payment and closing costs, then sign the paperwork confirming that you are now the legal owner of the property.
It’s always best to have a real estate attorney review the paperwork, especially if you purchase a commercial property like an office building.
Why Choose Pride Lending for Your DSCR Loan?
Pride Lending is dedicated to ensuring that investors have access to the funding they need to purchase the rental of their dreams. Our team includes allies and members of marginalized communities, including LGBTQ+ individuals and mortgage professionals of color, and we assist everyone, regardless of their background or identity.
We have deep experience in DSCR loans and can help you find the perfect product for your specific investment goals. Most importantly, we understand what investors look for in a loan product and will seek out the best opportunities for our clients.
Pride Lending is an award-winning LGBT Business Enterprise certified by the National Gay and Lesbian Chamber of Commerce. We are known for our no-compromise focus on helping the LGBT community achieve its financial goals.
Take The Next Step With Us!
If you’re ready to generate positive cash flow with DSCR loans, contact Pride Lending today! Get qualified to start the process of purchasing your perfect investment, or call us at 725-231-0192 to learn more about our specialized services for the savvy real estate investor. We look forward to serving you with pride.
