What is a DSCR Loan? What You Need To Know
Summary: What is a DSCR Loan?
A DSCR loan is a real estate financing option based on a property’s cash flow rather than the borrower’s income. Popular among rental property investors, DSCR loans help qualify borrowers using rental income potential. These loans are flexible, can be refinanced, and are ideal for scaling real estate portfolios.
Key Points:
• DSCR Defined: Stands for Debt Service Coverage Ratio; measures property income vs. debt.
• Eligibility: Based on property cash flow, not borrower’s personal income.
• Formula: DSCR = Net Operating Income / Total Debt Service.
• Typical Requirements: DSCR ≥ 1.0, credit score in 600s, 20% down payment.
• Credit Reporting: Loans usually don’t appear on credit reports, but related activity may affect scores.
• Refinancing: Allowed, including cash-out options – evaluate for potential penalties.
• Loan Limits: No set cap on the number of DSCR loans a borrower can have.
• Myers Capital Hawaii: Offers expert guidance and DSCR loan solutions for investors.
When you want to purchase a rental property or refinance an existing loan for a rental property, one of the most important things you can do is consider your options.
There are several types of investment property loans that real estate investors could choose, with each offering something unique compared to the rest. Bridge loans, portfolio loans, and fix and flip loans are just a few examples.
Today, we’re sharing key information about another type of investment property loan. Specifically, the Debt Service Coverage Ratio (DSCR) loan.
So, what is a DSCR loan and why do they make sense as a financing option for some real estate investors? Let’s take a closer look.
The Basics on DSCR Loans
A Debt Service Coverage Ratio loan, often called a DSCR loan, is a type of financing often used for short-term rental properties, including but not limited to condotel units. DSCR loans are also used for many other types of rental properties, like traditional apartment buildings and complexes. They can be used for refinancing and for purchasing a property.
The most unique aspect of DSCR loans is the income stream used to determine a borrower’s eligibility. Many loans take the borrower’s personal income into account, drawing on documents like W2s to verify the amount of money the borrower earns.
DSCR loans offer an alternative by focusing on the property’s cash flow instead of the borrower’s income. In essence, the lender uses the expected earnings of the property to decide whether issuing the loan is in its best interest.
So, DSCR loans can be a useful and powerful option when the borrower themselves doesn’t have a high income, but the property they want to purchase shows a strong return.
How Does a DSCR Loan Work?
DSCR loans work by measuring the cash flow of a property while also taking associated debts and expenses into account. Investopedia explains that the formula for calculating DSCR for an individual property (or for a business or similar entity) is relatively simple.
The DSCR formula is as follows: Net Operating Income/Total Debt Service. Here are a few key details:
• Net operating income is calculated by taking the gross operating revenue and subtracting operating expenses from it.
• Debt service is calculated by adding up the principal repayment, lease payments, and interest payments.
This calculation yields a DSCR ratio. As JP Morgan Chase points out, the figure tells the lender how much income is produced per dollar of debt service. So, a DSCR of 1.65 shows that a property earns $1.65 in income per every $1 of debt service. The higher the DSCR, the more income a property earns and, generally, the more likely a lender is to approve a DSCR loan.
How to Qualify for a DSCR Loan
Every lender has their own specific rules and requirements. However, there are a few standards for DSCR loans across the industry.
These include a minimum DSCR of 1.0, a credit score in the 600s, a minimum down payment of 20%, and evidence of the property’s actual or projected income.
These standards are flexible. Some lenders may have higher requirements, while others may have lower limits or make exceptions on a case-by-case basis.
How Many DSCR Loans Can You Have?
There is no legal, regulatory, or otherwise official limit to the number of DSCR loans a borrower can have. This is another reason why DSCR loans are a popular choice among real estate investors.
Do DSCR Loans Show on Credit Reports?
DSCR loans do not rely on personal income, so they generally don’t appear on credit reports. Activities related to the loan, like a late payment or a credit inquiry by a lender, can influence credit scores, but the loans themselves do not appear on credit reports.
Can You Refinance a DSCR Loan?
Yes, like many other types of loans, borrowers can refinance DSCR loans. Refinancing a DSCR loan is a popular choice when interest rates drop significantly and refinancing can reduce the amount of interest paid. Cash-out refinancing for a DSCR loan is another approach used by some investors.
Keep in mind that refinancing a DSCR loan may also lead to prepayment penalties and other financial obligations. Just like any type of loan, it’s vital to do the math and ensure refinancing will lead to the outcome wanted and not just a greater expense in the big picture.
Help With DSCR Loans from Myers Capital Hawaii
Myers Capital Hawaii is dedicated to helping our clients understand their loan options and choose the type of financing that best aligns with their unique needs. We are happy to discuss DSCR loans and how they could fit into your investing strategy with you. Learn more about our loans for investors.
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