With the way that the real estate and rental market have been inflating, you might be wondering if now is the time to invest, before the prices get too high and you miss your chance. The answer is; yes, the sooner you invest in real estate, the larger your profit will be–and it’s a lot easier than you would think! Self-employed investors lacking W2s and real estate investors with multiple mortgaged properties often have difficulty meeting the criteria of conventional loans, making it harder for them to grow their investment portfolios.
Debt-Service Coverage Ratio loans (or DSCR loans for short) can help real estate investors qualify for loans based on generated rental income rather than personal income. What this means is that when the lender is making decisions about the loan they will be based on what the property qualifies for, rather than what the individual requesting the loan would qualify for based on personal income–that being said, the individual requesting the loan must still have the funds to cover the capital of their investment, as well as an acceptable credit score. When used correctly, DSCR loans are an incredible tool that can greatly help property investors in growing their portfolios.
DSCR Loans Explained
Your debt service coverage ratio tells you the amount of net cash flow that you’ll have to cover your mortgage. It is used to determine whether or not a property can generate enough income to pay off the mortgage, and is used by lenders to decide what the maximum loan amount is that an investor qualifies for. The ratio is measured by dividing your property’s annual net operating income (NOI) by its annual debt service (mortgage, including principal and interest costs). The ratio that you are left with tells you what percentage of your NOI covers your annual debt payments. The higher the number, the better chance that you’ll be approved for a DSCR loan.
Getting and Using a DSCR Loan
Commercial property investors using DSCR loans are intended for single-family (1-4 unit) residential rental properties. Multifamily rental properties, short-term rentals, vacation rentals, or commercial properties. These types of loans are not typically approved for manufactured housing. Rural properties–including log cabins or dome homes–or properties with a square footage of fewer than 750 feet. Ultimately, different lenders will have opinions on what property types they think should be covered by a DSCR loan, so be sure to check, when looking at different lenders, to make sure that the property you’re wanting to invest in does meet their qualifications for DSCR loans, that way you won’t have any disappointing surprises.
Different lenders will also have different financial requirements for DSCR loan approval. Both for you and for the property that you’re looking to invest in. While DSCR loans don’t typically require W2s to be provided for approval. Making these loans perfect for self-employed investors who might not have one. Lenders will have their requirements regarding a loan applicant’s credit score. Typically seeking a score of 680 or higher for approval. Needing proof that the applicant will be reliable in making on-time loan payments. It is also customary for lenders to ask for the applicant’s bank statements from the months leading up to their loan request.
This is so they can see proof that, even if you are self-employed and lack a W2. You still have the funds required to cover the capital and can be financially trusted to pay back the loan. If you find yourself missing one or the other–a solid credit score. Or a consistent source of income–you should consider finding a partner to invest with. One who balances you out by making up for the things you lack. If you and your partner request a DSCR loan under an LLC. You can choose whose credit score is used and who shows proof of funds.
Applying for the loan under an LLC also helps to protect any one individual from bearing the responsibility of the loan. Keeping your and your partner’s financial records clean. However, not every lender is willing to allow financing for LLCs. So be sure to check with any potential lenders to see if you can still qualify.
While your ability–or the ability of your LLC–to pay off a DSCR loan is important. To potential lenders in deciding whether or not to give you approval. What’s equally important is the property that you’re hoping to invest in. Lenders will typically have required minimum property values for what they will approve loans for. The baseline tends to be around a minimum of at least 150k. Again, this minimum does vary from lender to lender. So it is important to do your research on how your property compares to the rest of the market. Check with any potential lenders on their property value requirements before you start applying for DSCR loans.