DSCR Loans Please Explain

[Nathan Frost]

Hi, can someone explain this to me? Basically give me an example of say a $100,000 home and how this is wise to use that rents for $1200-1400. Verse other loans. Or why one would choose DSCR loan / interest only payments over equity payments.

[Doug Smith]

DSCRs are used in place of conventional loans because of cash flow. I'll use your example for both conventional and DSCR and you'll see why.

CONVENTIONAL: Conventional financing will use a "Global Cash Flow" on you where they take into account all of your income and debts. let's say you make $1000/month (I know the numbers are silly-low, but go with me here for this example). Fannie/Freddie will want you to only have 43% (really closer to 50%...but 43% is the base guideline) of your gross income going out in monthly payments INCLUDING your new loans Principal, Interest, Taxes, Insurance, and HOA payments (PITI+HOA). So if you make $1000/mo, you can only have $430 going out. Now, let's say you find a nice property that brings in another $1000/mo in rent and the PITI+HOA are only $800/mo providing you with a positve cash flow of $200/month. Pretty great, right? Not for Fannie/Freddie. Let's redo the math... New Income = $1000 old income + $1000 rent = $2000. New Expenses: $430 + $800 = $1230 going out. Debt to Income Ratio (DTI...what conventional loans use) = $1230/$2000 = 61.5% DTI. That's way over guideline. The problem with using conventional financing is that you might be able to do it for one or two properties, but eventually, unless you have an insanely high income, the math no longer works.

The DSCR Loan (Debt Service Coverage Ratio) only cash flows the property. By the way, I was a commercial lender with banks for years. Commercial lenders use DSCR to calculate cash flow, but the way these new DSCR calculate income is not how a bank is going to calculate DSCR. A DSCR lender is only going to look at the gross rent as stated by an appraiser on the Appraisal form 1007, and then the are going to divide that by PITI+HOA...that's it. So the DSCR caculation is the inverse of the conventional way of calculating cash flwo (DTI). DSCR, for our purposes, = Rental Income from the 1007 / PITI+HOA. Your bank or credit union will add stuff to the denominator like management fees, vacancy factors, maintenance factors, etc and they will likely want to see the numerator show a history of returns as opposed to using what the appraiser states on the 1007.

So the utility of the DSCR is that it allows you to scale past your first couple of deals. Since it only looks at the cash flow of each property, the math makes it so you can keep going and going as long as you have the credit and the 20%-25% per deal (plus closing costs and reserves) to do each deal.

I hope that helps you. Good luck to you!