DSCR Loans: What Are They and How Can They Benefit Me?

By Dennis Spivey, Vice President at CoreVest

You may have heard the term “DSCR Loan” increasingly floating around. Due to shifts in the market, it has indeed become a hot topic amongst lenders and real estate investors. But what is it, and how does it work? Let’s explore the mechanics behind DSCR loans and how they can help further your real estate investment portfolio.

The term “DSCR” is an acronym for “Debt Service Coverage Ratio.” Simply put, it is the function of net operating income, “NOI,” on a property divided by the principal and interest payment for that same property. Lenders who issue DSCR loans use this figure to determine the max amount of loan that a property could qualify for based on its cash flow. This is because the lender wants to make sure that the net monthly income of a property is equal to or higher than the mortgage payment. A DSCR of 1.00x means that the NOI is the same as the mortgage payment or “break even”. If a lender requires a DSCR of 1.20x, this means that the lender wants the NOI to be 20% higher than the mortgage payment, so that there is a buffer.

When a DSCR lender is reviewing a property for a potential loan, they will look at average annual expenses in order to calculate a net operating income, or NOI. If you’ve ever owned a rental property, you understand that things like taxes, insurance, and HOA fees take away from your actual monthly and annual profit. Most lenders want to understand the “real” amount of income that an investor recognizes from a particular investment. They do this in a few different ways, but in general, they look at actual expenses that have been incurred by the property for the past 12 months. In some cases, the property may not have a full year of operating history. When this happens, they will look at verifiable line items, like property taxes and insurance, and simply annualize them.

Let’s now put this all together in a real scenario. Let’s say borrower “X” owns a single-family rental property that’s worth $200,000. The gross monthly rent on the property is $1,500, or $18,000 annually. After reviewing operating costs, the lender calculates a NOI of $12,600, or $1,050 per month. In this scenario, let’s say the lender has a minimum DSCR of 1.20x. This means that the net income of $1,050/month needs to be 1.2 times the principal and interest payment of the proposed loan. Using an interest rate of 6% as an example, the lender then figures out that a loan amount of $146,000 creates a monthly payment of $875, which is the payment amount that would create the 1.20x DSCR they are looking to achieve ($1,050 NOI divided by $875 payment = 1.20x). Notice that in the above example, the property owner’s personal income is not considered. As such, the borrower would qualify for a $146,000 mortgage completely based on the revenue generated by the property itself. This is what is unique, and in many cases very helpful, about DSCR loans.

The property itself are the income and qualifiers for the loan, not the individual or entity that owns it. Why is this advantageous you ask? It’s useful because many investors use the tax benefits of owning rental properties to reduce their income tax exposure. While this is great for the investor, it hurts them when a bank needs to calculate income from their individual tax return. Things like depreciation, renovations and maintenance help dilute how much of the income is taxable, but at the same time they dilute how much income an investor can use to qualify for a bank loan. With the DSCR loan, typically no income is calculated off personal tax returns. The borrower is simply given a loan based on the in-place rent of the subject investment property and a few other usual credit factors.

Now, let’s discuss how DSCR loans can be helpful in expanding your rental portfolio. In the same way that an investor can use a DSCR loan to refinance an existing rental property, these loans can also be used to purchase additional rental properties and help grow the portfolio. If the property being purchased is already leased, the lender will use the in-place rent to qualify for the loan. If it is not already rented, the good news is that the lender will still give credit using a “market average rent” for the property being acquired and use it to qualify for the future payments of the loan.

At CoreVest, we offer a few different types of “DSCR loans”. We offer loans for individual rental properties which is what DSCR is typically known by, but we also offer Rental Portfolio Loans that combine multiple rental properties. These properties could be condos, houses, 2-4 units, and even multifamily apartments. For our rental portfolio loans, we aggregate the total rental income for a group of properties and divide that by the payment of the blanket loan that will ultimately encompass the entire portfolio. This allows you, as the investor, to use multiple rental properties in combination to achieve a higher loan amount. These loans can be used to consolidate, refinance multiple existing loans, pull cash out, or even to acquire a group of properties at the same time.

CoreVest is a market leader in rental loans, also known as DSCR loans, and has helped thousands of investors finance their properties and improve their holdings. We’d love to talk with you directly on how we can maximize the value of your rental or investment portfolios. Give me a call today at 805.760.0660 or email or email [email protected] to discuss how CoreVest can help you grow!

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