Debt Service Coverage Ratio Loans

Every real estate investor should be aware of a unique type of loan that can be used to support property investments. Known as a debt service coverage ratio (DSCR) loan, these loans use a special calculation to qualify you as a borrower. Here’s what to know about using a DSCR loan to your advantage as you continue building your portfolio.

What Is a DSCR Loan?

DSCR loans are investor loans that rely on your debt service coverage ratio to qualify you for a loan. Lenders use a measurement tool to calculate your DSCR. Small variations in measuring your DSCR may exist from lender to lender. But all ratios will involve calculating your net operating income (NOI) and dividing that by your debt obligations.

To illustrate, consider that you are interested in acquiring a property that will generate a net operating income of $60,000 but has an annual debt of $45,000. Your debt service coverage ratio for this property would be 1.5. DSCR ratios above one indicate profit. A DSCR of one is a breakeven ratio. A DSCR of less than one is unlikely to be approved because the income will not cover the debts. Since the DSCR in this example is 1.5, the lender can confirm that the property income will cover the debts. And a positive cash flow will be realized.

Benefits of DSCR Loans

The major draw of DSCR loans is that they don’t involve your personal income. In this regard, they are akin to a stated income residential loan. The lender is more interested and concerned with the cash flow generated from the property than they are with your personal earnings. For this reason, debt service coverage ratio loans often appeal to self-employed real estate investors.

Close Faster on Your Loan

A second benefit of applying for an investor loan such as a DSCR is that it may close faster than other types of loans. As a no-income loan, you will not have to provide paystubs. Nor will you need to prove your employment history, which often appeals to freelancers, contractors, and consultants. For those who own their own business, you may even be able to close a DSCR loan in your business entity’s name. Which helps keep your personal and business operations separate.

Expand Your Portfolio

A third benefit real estate investors may enjoy is the down payment requirements of a DSCR loan. Although different lenders have different requirements, most will need a 20-25% down payment on the investment property to approve you for the loan. While that is a larger down payment than you may be required to put down for a home loan, it can make the purchase of another property for your portfolio very manageable.