The Top 3 Things You Need To Know About DSCR Loans  

Real estate is one of the best investments out there. It has the power to create long-term, multi-generational wealth while providing financial stability. And one of the best types of real estate investment is rental properties. Whether it’s multi-family housing or vacation properties, rental properties offer an excellent return on investment. This is why it’s good to know about DSCR loans.

There are some challenges that come with investment properties, including financing. Compared to single-family properties, many types of investment loans have a greater barrier to entry, including larger down payments, higher interest rates, higher credit scores, and in some cases, more scrutiny of your personal finances.

Fortunately, there are many types of loans out there for real estate investors, including DSCR loans. So what is a DSCR loan and how does it compare to other types of loans on the market? A DSCR loan, or a Debt-Service Coverage Ratio loan, is a measurement of a rental property’s cash flow versus the current debt obligations. For rental properties that generate a positive, measurable income, a DSCR loan can be a fantastic alternative to more traditional types of loans. 

Before applying for a DSCR loan, there are certain things you need to take into consideration. Here are the top three things you need to know about DSCR loans.

1. The Numbers Matter

Unlike many other types of loans, such as conventional or FHA loans, Debt Service Coverage Ratio loans allow borrowers to qualify for a loan based solely on an investment property’s cash flow. This means the borrower’s personal finances are not taken into account when applying for a DSCR loan. If you have an established rental property with consistent, positive cash flow, but you don’t want to apply for a loan based on your personal income, your credit score, or your tax returns, then applying for a DSCR loan can be an excellent alternative.

So you know about a DSCR loan, but how is a debt service coverage ratio calculated? A DSCR’s metric is based on the “ratio” of cash available to the “service” of your debt. Or, the amount of cash you have available to pay both the principal and the interest payments for your loan. How it is calculated is the net operating income divided by the debt service of the loan.

DSCR = NOI ÷ DEBT SERVICE

In most cases, your DSCR must be at least 1 or higher in order to qualify for a DSCR loan. However, most lenders want to see a minimum DSCR of 1.25 or higher.

That said, if you are operating at a net loss at any point during the life of the loan, you must use your personal finances to cover the difference or risk defaulting on the loan.

2. DSCR Loans are Versatile

Of the many perks of a DSCR loan, one of the biggest pros is its versatility. Along with more scrutiny, most conventional and FHA loans require borrowers to make a one-time commitment to a single property. This limits their ability to take out loans for additional investment properties until the initial loan is paid off. Unlike many other loan types, you’re allowed to commit to several properties at once with a DSCR loan. This is great for investors who are trying to increase their portfolio, allowing you to scale your business at a much faster rate.

Not only can borrowers take out several loans at once, DCSR loans often have much faster closing times than most commercial loans. This is because, with most traditional loans, loan processors and underwriters have to examine pay stubs and conduct background checks on your employment history before moving forward with the loan. And since the only numbers that matter for a DSCR loan are the property’s cash flow, the process is much more streamlined.

3. There are Limits to DSCR Loans

There are so many benefits to DSCR loans. They are a fantastic tool for real estate investors with profitable income properties who wish to increase their portfolios at a faster rate. That said, certain limitations need to be taken into consideration before applying for a DSCR loan. On average, DSCR loans require a 20% – 25% down payment, depending on the lender. Another major expense is the lender and service fees, ranging from 0.5% to 1% of the entire loan. As a result, mortgage rates for DSCR loans are typically 1.000% to 2.000% higher than rates on most traditional loans.

Another major downside to DSCR loans is the limitations of financing. The maximum amount investors can borrow from a DSCR loan is $5,000,000 or less. For investors who need to borrow a larger amount, a DSCR loan is not the right option for them. Keeping these limitations in mind, however, DSCR loans are great for borrowers who meet these specific guidelines.

Are DSCR Loans Right For You?

With so many types of loans out there, it can be overwhelming to know where to start. And while traditional commercial loans work for many investors, many situations exist where alternatives need exploring. For real estate investors with established properties that generate positive cash flow, a DSCR loan is a fantastic tool for scaling your business and taking your portfolio to the next level.

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