How Does a DSCR Loan Work?

Say you’re looking into getting an investment property loan, a rental property loan, or even a fix and flip loan, and you run into the term, “DSCR loan.” Here might be the flood of thoughts that immediately rush through your brain:

“Huh?”

“What even is a DSCR loan?”

“Ugh.”

“Another business acronym.”

“It sounds complicated.”

“Forget this.”

Trust us, we get it. (Especially the whole acronym thing…the worst.)

That being said, a DSCR loan isn’t as complicated as you think. In fact, once you know what a DSCR loan is and how it works, it can be an incredibly effective way to get a loan for an investment property.

DSCR simply stands for “debt service coverage ratio.”  It’s a formula used to determine if there is enough cash flow from rental income received on the property to “cover” or “service” the outstanding monthly debt on said property. Your DSCR will not only determine whether you get financing for a property in the first place, but it will absolutely determine whether your investment will be successful over the long term. It’s crucial that you know your DSCR in order to properly evaluate the profit potential (as well as potential risk) of any rental property you might be acquiring.

So now that you know what a DSCR loan is and what it stands for, you need to know how a DSCR loan works. And before you start screaming, “NO MATH! NO MATH!”, we here at loanguys.com are here to tell you that it’s not as bad as you think.

Trust.

The formula for calculating debt service coverage ratio is pretty straightforward. The DSCR for real estate is calculated by dividing the annual net operating income of the property (NOI) by the annual debt payment.

That’s it.

Now, usually, anything between a 1.1 and 1.2 DSCR calculation (meaning the rent is 100% to 120% of the monthly expenses) is considered a sufficient cash flow to cover the outstanding monthly debt, which typically consists of principal, interest, taxes, insurance, and any dues if part of a condo association.

If your DSCR is below 1.0, well, that means the property doesn’t generate enough cash flow to cover its debt obligations and, frankly, you are kind of out of luck. The higher your DSCR metric is above 1.0, the more likely there’s enough of a cash-flow cushion to cover debt obligations, which is the sweet spot you really want.

Ok, you’ve got all the info about what a DSCR loan is and how a DSCR loan works. So what, right? What’s that have to do with you and your plans to invest in income rental property? Well, it turns out…A LOT.

The main benefit of a DSCR loan is that it allows money lenders to focus more on borrower credit and property cash flow and less about the borrower’s personal income. When investing in real estate with a DSCR loan, you don’t need proof of income via tax returns or pay stubs because either you don’t have it, or your income doesn’t represent your true income due to write-offs and business deductions. Even better, DSCR loans do not report to the three main credit bureaus (Experian, Equifax, and Transunion). As a result, these loans do not affect your Debt to Income Ratio that conventional money lenders look at.

An additional benefit of a DSCR loan is that many money lenders will allow borrowers to purchase properties in the name of an LLC or corporation which is typically something that conventional lenders will not allow. This is highly beneficial to investors as holding a property in an LLC has potential tax benefits to the investor and reduces exposure from a liability standpoint. Not bad, huh?

And, after all this, if you’re wondering, “Whatever. Why don’t I just go get a conventional loan like everyone else does?” Well, you can. Conventional loans are great for certain real estate investors who have conventional investment loan needs. The thing is, with conventional loans, there are very specific underwriting guidelines that each loan needs to meet. Income, assets, credit, and collateral are all carefully reviewed to make sure that each conventional loan meets proper guidelines so that it can be a loan that will be “saleable” to Fannie Mae or Freddie Mac, who packages these loans as mortgage backed securities (MBS) and sell these MBS’s to investors around the world.

Also, though you may get a lower interest rate with a conventional loan than with a DSCR loan, it will be way more time consuming and much more of a difficult process for the borrower to get the loan approved. The process and documentation requirements for DSCR loans are much less restrictive than conventional loans. Because of this, loanguys.com can actually fund investment rental loans much faster than conventional lenders can. We can fund as quickly as 10 to 14 business days. Yeah…that is crazy fast!

So, there you have it. Now you know how a DSCR loan works. And you know what they say: Knowing is half the battle.

They say that, right?