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.

[Chris Seveney]

@Nathan Frost

People will look to dscr as an option over conventional financing

Typically they will have a loan to value requirement and the dscr ratio of say 1.25

Here is a good link to read

https://www.firstrepublic.com/insights-education/what-is-debt-service-coverage-ratio#:~:text=A%20debt%2Dservice%20coverage%20ratio%20of%201.25%20translates%20to%20a,health%2C%20which%20is%20always%20helpful.

[Devin Peterson]

DSCR options are a good program for investors who want to avoid the red tape of fannie/freddie. You also have the option to close in an LLC and many other beenefits that allow you to scale qucikly. DSCR = gross rent / PITI(A) Generaly, 1.00-1.25 is a standard ratio to get you some favorable terms

[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!

[Robin Simon]

Quote from @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.

High level of pros/cons of DSCR Loans vs. Conventional:

 Advantages of Conventional Loans

Lower interest rates and/or closing fees (typically 0.75% - 1.00% higher rate)

No prepayment penalties (no fees if prepay the loan early)

Standardized Rules and Guidelines – set by agencies and universal

Advantages of DSCR Loans

1. No “DTI” Ratio – conventional lenders will require a “Debt-To-Income” ratio that measures all of your income vs. all of your expenses, and can’t qualify under a certain percentage – even if the property should make money on its own

2. No LLC or Partnership option – must borrow as an individual for conventional, many like to partner up and get an LLC which can protect liability

3. Size Limits – Loan size is maxed at $726,200 so out of luck if wanting a bigger property

4. Concentration Limits – One person can get a max of 10 conventional loans, and typically less since DTI would need to qualify on each

u5. No Flexibility on Underwriting – no exceptions or forward-thinking underwriting for unique situations or newer asset types (short term rentals, etc.)

6. Significantly less “paperwork and hassle” – no tax returns, no documenting income and overall fewer headaches and documents. Also means fewer opportunities for something to “go wrong” and deal to be rejected

+ Prepayment Penalties not an issue if investor plans on holding the property for long-term cash flow (prepayment penalties will have a duration of 5 years maximum)

[Stacy Raskin]

DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth. They don't consider the borrower's income.

Here's a bit more in detail about how rates are calculated for DSCR loans:

1. Credit score- the higher the best. 780+ generally gets best pricing for investment property loans with most lenders

2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.

3. Are you cash flowing the property? Is your DSCR ratio greater than 1-meaning are you cash flowing. Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit.

4. Prepayment penalties generally range from 1-5 years and you get to decide the length of the term. The longer the term, the less of an impact on the rate.

I've included an example below to help illustrate this. So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.

See example below:

DSCR < 1

Principal + Interest = $1,700

Taxes = $350 Insurance = $100 Association Dues = $50

Total PITIA = $2200

Rent = $2000

DSCR = Rent/PITIA = 2000/2200 = 0.91

Since the DSCR is 0.91, we know the expenses are greater than the income of the property.

DSCR >1

Principal + Interest = $1,500

Taxes = $250, Insurance = $100 Association Dues = $25

Total PITIA = $1875Rent = $2300

DSCR = Rent/PITIA = 2300/1875 = 1.23

Lenders will typically let investors vest as an individual or an LLC.

[Erik Estrada]

Quote from @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.

 Hey Nathan, 

DSCR loans are best used for investors that cannot show income/have too much debt or have tapped out of their conventional loans.

Qualifications are based on FICO and the rents covering the full mortgage payment. I have seen interest only options used when the debt ratio is very tight. 

[Denzell Hawkins]

@Chris Seveney

Also they typically want 100K as the minimum loan amount. At 20-25% down you’d be borrowing a max of 75K so they may object due to not enough “meat on the bone”.

[Nathan Frost]

Quote from @Stacy Raskin:

DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth. They don't consider the borrower's income.

Here's a bit more in detail about how rates are calculated for DSCR loans:

1. Credit score- the higher the best. 780+ generally gets best pricing for investment property loans with most lenders

2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.

3. Are you cash flowing the property? Is your DSCR ratio greater than 1-meaning are you cash flowing. Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit.

4. Prepayment penalties generally range from 1-5 years and you get to decide the length of the term. The longer the term, the less of an impact on the rate.

I've included an example below to help illustrate this. So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.

See example below:

DSCR < 1

Principal + Interest = $1,700

Taxes = $350 Insurance = $100 Association Dues = $50

Total PITIA = $2200

Rent = $2000

DSCR = Rent/PITIA = 2000/2200 = 0.91

Since the DSCR is 0.91, we know the expenses are greater than the income of the property.

DSCR >1

Principal + Interest = $1,500

Taxes = $250, Insurance = $100 Association Dues = $25

Total PITIA = $1875Rent = $2300

DSCR = Rent/PITIA = 2300/1875 = 1.23

Lenders will typically let investors vest as an individual or an LLC.

You still have to bring 20% to the table? Does the DSCR pay down on the principle of the property?

[Robin Simon]

Quote from @Nathan Frost:

Quote from @Stacy Raskin:

DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth. They don't consider the borrower's income.

Here's a bit more in detail about how rates are calculated for DSCR loans:

1. Credit score- the higher the best. 780+ generally gets best pricing for investment property loans with most lenders

2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.

3. Are you cash flowing the property? Is your DSCR ratio greater than 1-meaning are you cash flowing. Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit.

4. Prepayment penalties generally range from 1-5 years and you get to decide the length of the term. The longer the term, the less of an impact on the rate.

I've included an example below to help illustrate this. So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.

See example below:

DSCR < 1

Principal + Interest = $1,700

Taxes = $350 Insurance = $100 Association Dues = $50

Total PITIA = $2200

Rent = $2000

DSCR = Rent/PITIA = 2000/2200 = 0.91

Since the DSCR is 0.91, we know the expenses are greater than the income of the property.

DSCR >1

Principal + Interest = $1,500

Taxes = $250, Insurance = $100 Association Dues = $25

Total PITIA = $1875Rent = $2300

DSCR = Rent/PITIA = 2300/1875 = 1.23

Lenders will typically let investors vest as an individual or an LLC.

You still have to bring 20% to the table? Does the DSCR pay down on the principle of the property?

Yes - generally minimum equity down payment is going to be 20% on DSCR

And Yes - most DSCR Loans are "fully amortizing" i.e. each monthly payment will have a portion of principal that pays down the balance (although there are "interest-only" options that allow for interest only payments for the first 10 years of the term)

[Stacy Raskin]

Quote from @Nathan Frost:

Quote from @Stacy Raskin:

DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth. They don't consider the borrower's income.

Here's a bit more in detail about how rates are calculated for DSCR loans:

1. Credit score- the higher the best. 780+ generally gets best pricing for investment property loans with most lenders

2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.

3. Are you cash flowing the property? Is your DSCR ratio greater than 1-meaning are you cash flowing. Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit.

4. Prepayment penalties generally range from 1-5 years and you get to decide the length of the term. The longer the term, the less of an impact on the rate.

I've included an example below to help illustrate this. So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.

See example below:

DSCR < 1

Principal + Interest = $1,700

Taxes = $350 Insurance = $100 Association Dues = $50

Total PITIA = $2200

Rent = $2000

DSCR = Rent/PITIA = 2000/2200 = 0.91

Since the DSCR is 0.91, we know the expenses are greater than the income of the property.

DSCR >1

Principal + Interest = $1,500

Taxes = $250, Insurance = $100 Association Dues = $25

Total PITIA = $1875Rent = $2300

DSCR = Rent/PITIA = 2300/1875 = 1.23

Lenders will typically let investors vest as an individual or an LLC.

You still have to bring 20% to the table? Does the DSCR pay down on the principle of the property?

 @Nathan Frost, there are some lenders who will do 15% down for a DSCR loan if the middle credit score is 720 and the DSCR ratio is 1.2 so the rents are 120% of the expenses. So an easy math example would be if the rents were $1,200 and the mortgage, property insurance, taxes and HOA (if applicable) were $1,000 per month.

The DSCR loan can be structured in different ways including a fixed payment fully amortized loan which pays down the principal and interest over time.