Can you use DSCR loan for flipping?

[Mike Romano]

Hello,

I was wondering if you can use a DSCR loan for flipping? Does anyone use this loan for flipping?

Thanks,

[Alex Breshears]

Hi Mike! 

Your question is great because real estate is all about leverage and knowing the different tools in your tool belt can really help you build a real estate business plan. There is a wide variety of financing options, each with their own pros and cons. One is not necessarily better than the other. Think of loan products as tool you have to complete a job. While a hammer is great, it make not be super handy if you have to change out a light switch.

Since you mentioned DSCR, I'll address that one. This means debt service cover ratio. That's a fancy way of saying they want to make sure there is enough income coming in from the property to cover the debt on the loan (monthly mortgage payment for example). It is often expressed as a number that is the ratio of monthly projected income to monthly expenses. For example, a DSCR loan commonly requires 1.25 as the coverage ratio. Technically this looks at the net operating income as the numerator and then the monthly obligation on the bottom. For example, the monthly revenue projected for the property might be $3000, and the debt service might be $2000. If you divide $3000 by $2000 you get 1.5. This would be the debt coverage ratio a lender is looking at to determine eligibility for the loan product. Generally most lenders are around 1.25, I've seen a few in rare cases go as low at 0.75, but the rates and fees are much higher, along with capital requirements from the borrower.

What is the benefit to using a DSCR loan? Usually there is some aspect to the borrower lending profile that a borrower may not want to address with a new loan. For example, low credit score or low documented income might be a reason a borrower would want a DSCR loan. Some lenders do not check credit score at all, and I would think most aren't looking at personal income in general. Other borrowers may want the loan to be in the LLC name versus their personal name, so they will seek out a DSCR loan and close in the LLC name, and possibly have to personally guarantee the loan. This means that if the worst happens and loan defaults, if the property does not sell for the amount owed to the lender at auction, you are personally liable for the remaining balance. This is known as a recourse loan. Some DSCR lenders will do non-recourse debt, and others will do only recourse debt. Again, just depends on the lender, borrower, property and situation. Similar to a traditional hard money loan, they are going to require some level of a downpayment, depending again on the lender and situation, it could be anywhere from about 15% to 25% of the purchase price of the property. They likely are also not going to offer any additional funds for renovations. That is definitely one of the downsides. Another downside is that right now these are some pretty expensive loans. Most lenders are working around 8% to 9% as an annual interest rate. The length of the loan is also all over the map depending on the product, could be a short bridge loan type situation so it would be a shorter loan time, or it could be 15,20,25 or 30 years amortized. These have their place in the market place, but you just need to understand what you are looking to do and what your strengths and weaknesses may be.

Generally these loans are more of a buy and hold play, but if you need to close quickly without a thorough underwriting analysis on you as the borrower, these may be a good option since you are not holding the property for a long period of time. These also may be a benefit in that IF you cannot get it renovated in time or you decide to hold it versus sell it, the DSCR financing could potentially stay in place. And since you have a loan out on it already, if it does turn into a situation where you want to refinance into better terms, it is easier to do a rate and term refinance and they will go to higher LTV's than a straight cash out option. For example, a rate and term refinance may go to 75% LTV, versus a cash out that may be limited to 70% LTV.

I hope that helps!