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HMW #154: 3 things to know about DSCR loans

alan corey commercial deal finding dti interest rates lending no money scaling wait to buy? May 23, 2024

Read Time: 5.5 minutes

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If you don't have a ton of money or the best credit score at the moment, can you invest in real estate?  You might be surprised that yes, you can, as a lending product called Debt Service Coverage Ratio (DSCR) loans exist for this scenario.

Every real estate investor will hit a point where they run out of personal funds or they hit their DTI (debt-to-income ratio) that lenders look at to approve personal loans. If you find yourself in this situation, then you need to look at DSCR lending.



I know. So let's dig into the three things you need to know about Debt Service Coverage Ratio (DSCR) lending products so you can keep buying real estate.


1. Loan approval is just simple math


Here's how DSCR loans work: the house (property) must pay for itself. Debt service is just another name for your mortgage payment.

So they just need the property to cover their own defined debt service ratio. The formula is literally in the name.

The lowest I've seen is 1.25 DSCR. 

So if the mortgage (including principal, interest, taxes, and insurance) is $1000 a month (the "debt service"), then property must generate a minimum of $1250 (1.25x the debt service) in rent to get approved for the loan.

Why are banks willing to do this? They are taking the borrower out of the equation and focusing on the deal. If the property pays for itself with room to spare then it looks like a safe bet for lenders.

More likely the loan products with the best rates are going to require 1.4 DSCR, but that's business! More risk means more reward for both you and the bank.

The good news is it's just a simple formula you can do on your own to see if the bank will loan you money for the property you have your eye on.



If it's not mathin', then it's not probably not a good deal. Save yourself the pain and go find another property where the numbers do work in your favor. But if you really aren't sure, our lending partner Jasmine Mortgage Team can do the math for/with you.


2. DSCRs have higher rates


Because you are bringing a lower down payment to closing or your poor credit is officaly being overlooked, you most likely will pay that price in the form of higher rates.

However, higher rates are completely fine. Why? Because the higher rates are included in the formula above in order to get approved. If you can still hit a good 1.4x DSCR on a loan with higher rates, you probably have a property throwing off some excellent income.

Along with higher rates, it may also be a 20- or 25-year amortization rather than 30-year that you may have been used to. The loan may also have a rate adjustment period, or some other nuance that makes it different than a typical 30-year fixed residential loan.  

It's important to know the exact terms of your loan so you can be aware of the risks associated with these differences, but DSCR is an investor-only loan product and every lender handles them a little differently in an effort to get you the money you are looking for.




That's surprising accurate, Mr. Trebek (RIP).


3. Easier to get into, harder to get out of


Since DSCRs usually have a more streamlined approval process, the opposite is generally true on the exit. That means if you want to end your loan term earlier either through refinancing it (because rates have dropped) or selling the property (because you got a great offer), the loan often comes with a pre-payment penalty. The severity of this penalty is usually associated with how long you have had the loan, with the shorter time period being the most severe. Remember that the bank wants their money for helping you make money as this is how they do it!



I'm pretty sure you were when you accepted their money to start, just remember that!




It's okay, we all need partners of some sort in real estate investing.


In other words:

  • Real estate that pays for itself is a boon for you and for lenders
  • Understand the basic formula to find good deals
  • All money comes with strings attached

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