What is a Debt Service Coverage Ratio (DSCR) Loan?
A debt service coverage ratio loan, or DSCR is a helpful option to finance real estate investments. The real estate investment market has been promising for many and intriguing for some as it has been seeing a potential to generate income/ passive cash flow. When it comes to qualifying for a loan to back up these investments no two clients are going to have the same financial portfolio making a DSCR loan a good option.
Here are the basics of this type of loan:
How debt service coverage ratio loans are calculated
The calculation for these types of loans vary from lender to lender, but a general guideline is good to know and be prepared for should you decide to apply for one as an investor. Debt service coverage ratio loans are calculated using a formula of net operating income divided by debt obligations. So if an investor was looking to purchase a property with a net operating income of $40,000 and an annual debt of $32,000 the debt service coverage ratio will be 1.25. This means that the property will generate 25% more income than what would be needed to pay off the debt obligation (or cost of the investment property). In this example the property will be generating a positive cash flow. This valuation tool gives the lender a quick break down to the borrower’s ability to make payments on their debt obligation and sustain a profit from real estate investment. Other requirements will need to be met to qualify for a debt service coverage ratio loan, but the ratio calculation is the largest qualifying factor.
Why choose a debt service coverage ratio loan?
One of the main benefits of this type of loan is that personal income calculation is not required. Lenders are focused more on the cash flow of the investment property that you plan to purchase. This interest erases the need to turn in any stated income as well as erases the need for employment verification. If you are self-employed or have a gap in employment history this type of loan is much more promising as a means to become a real estate investor. This also allows investors to close a loan in their business name to further separate personal information from business information.
In addition to all of those benefits, a debt service coverage ratio loan has a potentially quicker closing time than other types of investment loans. Without the need for income verification or a job history check or any stated income needed this could potentially lead to a quicker closing time on your investment property loan. This is great news as many investment properties enter in bidding wars during the current market allowing your offer to become even more promising to a seller.
What is the down payment requirement for a debt service coverage ratio loan?
The general down payment requirements for this type of loan are anywhere from 20 to 25% depending on the specific lender you are applying for a loan from. Other avenues of purchasing investment properties can require full payment such as in a Sheriffs sale. This loan does not require a large lump sum of cash. This is a good way to get started in real estate investment if you do not have a huge chunk of cash to purchase a home for business purposes.