MortgagesOct 13, 2023

Debt Service Coverage Ratio (DSCR): No-Income Mortgage Loan

The most important thing about investing in real estate is numbers. If they work, everything else tends to fall into place. And in the US, those numbers are – 3,81 trillion dollars, (the value of the US real estate market). With so much money on the table, it’s no wonder that a lot of people are interested in making property investments. And, when it comes to investing – it’s better to do it with other people’s money. 

Using mortgage loans to invest in rental properties is a textbook example of good debt. The tenants will repay the entire debt through rent. The months will go by and the property owner will increase their equity share without having to worry about making mortgage payments. If the numbers are good, there could be enough “skin in the game” left for the property owner to earn a passive income. And even if the numbers don’t allow for a substantial passive income, the property owner will still have someone else pay for their loan, while they slowly but surely lower their debt and increase their equity in said property. 

However, not every would-be investor has an adequate W-2 form or a high enough credit score to qualify for regular mortgage loans. So, what can they do? 

The answer is —   DSCR mortgage loans. 

What Is the DSCR?

The debt-service coverage ratio (DSCR) is a standard measurement that specific types of lenders use to evaluate the borrower’s capacity to repay a loan. Or, in more simple terms, DSCR is measure of a property’s financial health.  

With DSCR, real estate borrowers can more easily qualify for a property investment loan. Types of loans that use DSCR metrics don’t have any specific requirements based on personal income and job history, The most important thing that can qualify you for this type of loan is your cash flow. Which, in the case of real estate properties, is rental income

a woman calculating a dscr loan conditions for the lander

What Are DSCR Loans?

DSCR-type loans are non-qualified Mortgage (Non-QM) loans, which means they are usually offered by private lenders and not banks. These loans do not meet the standards of the Consumer Financial Protection Bureau (CFPB) set to ensure borrowers can repay their loans. They also aim to mitigate various risk factors that the lenders are taking. Some CFPB mortgage loan standards include:

  • Maximum loan term of 30 years.
  • The borrower’s debt-to-income ratio (DTI) should be around 43% or lower. 
  • The mortgage loan has to have a fixed interest rate. If the loan is an adjustable-rate mortgage (ARM), there are certain restrictions that both borrower and lender need to adhere to.
  • The lender has to consider the borrower’s financial information – any physical or other types of assets, employment status, credit history, and other relevant information to make sure that the borrower can actually repay the loan.

As we’ve said above, DSCR loans are non-QM loans that are not regulated by the government. They are offered by private lenders and the specific terms and conditions for every loan can vary, depending on the particular lender. It’s also important to mention that not every lender will offer DSCR loans. 

Before approving your loan, lenders that deal with DSCR-type loans will look at rental income to check if you qualify for the mortgage loan.

DSCR loans are investor-only loans, and are not meant to be used by anyone looking to purchase their main home. The purpose of these types of loans is to allow investors to buy rental properties, both short and long-term ones. Also, these loans are great for new investors that are just starting out, as well as those more experienced looking to expand their portfolio. 

Connect with the best DSCR loan lender, get in touch with our mortgage broker today!

Main Advantages of DSCR Loans

We’ve already mentioned that, when it comes to DSCR loans, lenders are not, for the most part, going to be looking at your credit score or personal income, but rather the rental income of a particular property. This means that a DSCR loan will have:

  • Increased accessibility – Whether you are eligible for the loan or not will be solely determined by the DSCR. Lenders will not take into consideration any other factors (such as private financial information) when making their decisions. This means that a DSCR loan will be available to a higher number of borrowers, as opposed to other types of investment loans.
  • Easier approval procedure – A typical DSCR loan will have a much easier approval process, due to it not requiring extensive financial information.
  • Different types of rentals that qualify – A DSCR loan allows borrowers to invest in various types of rental properties, such as short or long-term rentals, single-family homes, apartment buildings of various sizes, commercial properties, etc.
  • Long-Term Sustainability – DSCR loans mitigate the risk of investing in real estate and aim to ensure that each property can generate enough income to cover all debt payments as well as any additional costs. This helps borrowers prevent financial difficulties, foreclosure, or defaulting on their loans.

Main Disadvantages of DSCR Loans

Just like with any other type of loan, DSCR loans also have certain disadvantages or cons. The most common of them are:

  • Limited amounts of money for financing – DSCR loans have a range between $100,000 and $5,000,000. This means that they limit the borrower’s ability to invest in more expensive markets or purchase multiple properties with a single loan.
  • Big down payments – Depending on the exact lender, down payments for DSCR loans can be at 20% or higher. This means that for a minimum loan of $100,000, you’ll have to set aside at least $20,000 for a down payment.
  • Exclusively for rental properties – DSCR loans are not for buying primary residences or fixing homes in order to flip them. They are solely for the purpose of buying investment rental properties (both short term and long). 
  • Expected constant cash flow – DSCR is calculated based on the assumption that a property will never be vacant and that it will always generate a steady amount of income. That won’t always be the case, and if borrowers are unable to find tenants for a prolonged period of time, they might end up deeper in debt. 
  • Higher interest rates – DSCR loans usually have around 1% higher interest rates, when compared to regular mortgage loans.

How to Calculate DSCR in Real Estate? – Example

Let’s say that you’re interested in buying a property worth $200,000, with a rental income of $3,000 per month. Now, let’s also take those numbers as our starting point for DSCR calculation. 

Property Value (PV) = $200,000

Monthly Rental Income(Gross income)(MRI) = $3,000

The formula to calculate the DSCR is relatively simple and it goes:

DSCR = NOI / Debt Service

So, in order to determine the DSCR of a particular property we first need to calculate – Net Operating Income (NOI) and Debt Service (DS). Let’s review those two, before we move on with calculating DSCR, for this specific example.

mortgage broker showing how to calculate NOI

How to Calculate NOI?

The way you can calculate NOI is by deducting all operating expenses from all incomes that a specific property generates. 

But, before we move on with determining NOI, we should mention that some lenders may use gross income (GI) instead of NOI to calculate DSCR. However, this is less common, and it is generally not considered to be as accurate. NOI is a better measure of the cash flow available to pay debt service, because it takes into account all operating expenses. Now, let’s get back to it. 

In the case of our example, the property is generating an MRI of $3,000. The property also  has Operating Expenses that include:

  1. Property Tax $200 
  2. Property Insurance $100 
  3. Repairs and maintenance $300
  4. Property management $300 
  5. Vacancy Rate 10% $300

This makes the total for operating expenses $1200. So let’s input those numbers and calculate the NOI:

Net Operating Income = Monthly Rental Income – Operating Expenses

NOI = $3,000 – $1200 = $1800

To calculate the yearly NOI all you have to do is multiply the above number by 12. In that case, NOI will be: 

NOI = $1800 x 12 = $21,600

By calculating the annual NOI we are one step closer to determining the DSCR, for our example property. For now, let’s move on to Debt Service.  

How to Calculate Debt Service?

Debt Service (DS) is the amount of money you’ll have to spend on repaying the loan, each month. It is determined by: 

For this example, we’ve chosen a property that’s worth $200,000.

Let’s say that the downpayment is the usual 20%, and the interest rate is 8% (or 0,08 expressed in numerals). That would mean that our actual loan principal is $160,000 ($200,000 minus the 20% for the down payment). 

To determine the monthly payment we have to follow the formula where:

  • P is the monthly loan payment
  • a is the principal
  • r is the interest rate
  • n is the number of payments you’ll make each year (12)

P = a (r / n)

P = 160,000 (0,08 / 12) = 1066

Finally, now that we have monthly loan payment we can calculate the yearly Debt Service:

DS = 12 x 1066 = 12,792

And, with that number in hand, we can finally go back to calculating DSCR. 

There and Back Again: The DSCR Journey

Let’s input the numbers we’ve got to calculate the DSCR of our property. 

DSCR = NOI / DS

DSCR = $21,600 / 12,792 = 1,68

If all of these formulae seem too complicated, feel free to try our DSCR calculator. With it, you’ll quickly realize that calculating DSCR is not that difficult, even if it does seem complex at first glance.

mortgage broker found the best lender for dscr loan

How Do DSCR Loans Work in Real Estate?

DSCR is there to help lenders calculate whether or not a potential borrower can repay the loan with solely the rental income of a specific property. 

For example, if DSCR is 1, the lenders will know that a particular property can generate just enough income to repay the loan. However, the problem with DSCR of 1 is that it doesn’t allow for any additional expenses such as property management fees, various types of repairs, maintenance, and similar. 

For those reasons, most lenders don’t typically give out loans to properties with a DSCR that is below 1,25. A DSCR of 1,25 gives assurances to lenders that there will be enough income to cover the loan payments and any additional expenses that might occur.

The higher the DSCR is the lower the risk for lenders is. The lower the risk is, you will be able to find more of them interested in giving you a loan, and it will be easier to qualify for larger loan amounts. 

Before getting a DSCR loan try and find as many lenders as you can and try to find out all the pros and cons of DSCR loans. Check them all out and see which of them want to finance your rental property investment. You should “shop around” as much as you can to find the best deals (including the best DSCR ratio, interest rate, initial down payment, etc.). Once you’ve gathered enough information about the specific terms and conditions from various international mortgage lenders, it’s time to compare their offers and figure out which one suits you be.

What Are DSCR Loan Requirements?

Before we talk about the most common types of DSCR loans and how you can get one, let’s first review some of the basic requirements you’ll need to consider when applying for these types of loans. 

1. DSCR 1 or Higher

You can calculate the DSCR with a formula: 

DSCR = NOI / Debt Service

If the real estate property you’re interested in has a DSCR of 1, this means that the GRI is equal to all mortgage payments and other types of expenses that you need to cover. 

A lot of lenders will consider DSCR 1 as sufficient to allow you to qualify for a loan. But, it’s also important to mention that the DSCR formula assumes that the rental property will always have tenants ( 100% occupancy), which is not often the case. And, it doesn’t take into account any additional expenses, such as property management, regular maintenance, or repairs.

For those reasons, it’s better to look for properties with higher DSCR that have a better cash flow. This will allow you to not only pay your debt but also to earn some additional income to cover other expenses (both planned and unexpected ones). 

And lastly, there are some lenders that will help you with financing even if the DSCR of the property you’re interested in is less than 1 (meaning, the property will effectively lose money). However, they usually come with much higher down payment requirements, interest rates, and other types of terms that can greatly favor the lenders. With a DSCR of less than 1, the risk for lenders is higher, so you should expect them to mitigate that in any way possible (including offering you an unfavorable deal).

2. Down Payments Between 20-25% Of Property’s Value

Lenders that offer DSCR loans might not ask for your personal financial information, but they will require a substantial down payment – usually between 20-25% of the property’s value. This is to make sure you have enough equity in the property, that you are fully committed, and don’t intend to default on your mortgage loan. Or, in terms that most people can understand – DSCR loan lenders want you to put your money where your mouth is.

As we’ve said already, the most common percentage for down payment will be around 20-25%. However, it’s important to mention that this too can vary, depending on the specific lender, DSCR, exact loan amount, credit score and history. As this is a NON-QM loan, the exact terms and conditions of each loan will be set by the lender.

3. Loan-To-Value between 75-80%

The loan-to-value (LTV) is a metric that determines the amount of money you can borrow in comparison to the property’s value. When it comes to DSCR loans, LTV is usually between 75-80%, but can also vary based on different factors, such as the specific lender, your credit history, loan amount, and more.

For example, if the house you’re interested in is valued at $200,000 (yes, there are houses under 200k), the LTV of 80% would equal $160,000. This means that, for this particular situation you can borrow $160,000 from the lender and will have to prepare a down payment of $40,000. 

4. Appraising the Property and Following the 1007 Rent Schedule Form

Before giving you a loan, lenders will hire and appraise to evaluate the property you’ve shown interest in to determine its value. This will help the lenders decide on the exact loan amount they can offer you. 

Apart from evaluating the property, appraisers will use the 1007 rent schedule to estimate the fair market rent of that specific rental property. This estimated rent will later be used to calculate the DSCR. 

If the property has a lease on it, appraisers might use it instead of the 1007 rent schedules forms to determine the rental amount. In that case, the lease will be used for DSCR calculations.

lander is giving money to the real estate investor

5. Enough Cash Reserves or Other Financial Assets

To further mitigate the risk, some lenders might want you to have a certain amount of money in your bank account/s or enough cash reserves (including various types of financial assets). How much money lenders will want you to have exactly, can depend on many factors. But, the usual amount they are looking for is enough money to cover somewhere between 6-12 months of loan repayments. 

6. Minimum Credit Score Of 620 or Higher

In a lot of cases, DSCR loan lenders will require you to have a credit score of at least 620. And, even though they are not interested in your financial information per se, lenders will still use your credit history as a means to reduce risk for themselves. 

A higher credit score indicates that a borrower is more reliable and will be more likely to repay the debt. Lenders will also be more open toward borrowers with higher credit scores, which can result in more favorable deals for those investors (lower interest rates, down payments, etc.)

What Are the Most Common Types of DSCR Loans?

There are a number of different types of DSCR loans. The most common of them are:

  • Fixed-rate – The interest rate is fixed for the entire loan term, and the DSCR ratio can not change, making this a good option for anyone looking for a long-term rental investment opportunity.
  • Adjustable rate – Tied to market benchmarks (e.g., SOFR index), adjustable-rate loans allow for DSCR fluctuations (the ratio can go up or down depending on the specific market benchmark). This is a good option for investing in short-term rental properties as the prices tend to change more rapidly, than those of long-term rentals.
  • Interest only – This type of DSCR loan allows borrowers to only pay interest for a specific time period, after which they have to make standard payments (both principal and interest). 
dscr loan contract

How to Get a DSCR Loan?

Getting a DSCR loan and going through the entire process of applying for it can be complicated. For those reasons, we’ve created a 7-step summary to make the procedure much easier to navigate. And, before we share these steps with you, we also have to note that these are general steps, and can vary depending on the specific lender. 

Let’s dive in.

Optional Step – Open an LLC

DRCS loans don’t require personal financial information or W-2 forms. This means that they can be taken by entities (various types of companies or LLCs) and individuals alike. Because of that, it might be a good idea to open an LLC and use it to apply for a DSCR loan. Having an LLC can safeguard your personal assets, and protect you from liability in the case of a default.  

1. Find a Suitable Lender

The first step is always the most important one, and in the case of getting a DSCR loan, it’s – finding a suitable lender. Because they will almost certainly be private lenders, all of them will have specific terms for DSCR loans. Meaning, they are going to be different depending on the lender. 

Your goal is to find the best option for your specific financing needs. And to do that, you should look into as many lenders as possible, to find the best DSCR loan deal.

If finding a mortgage lender seems too difficult, or you simply don’t have enough time to check out every single one of them, don’t fret. We at NRI operate as a mortgage broker and are licensed in all 50 states. We can help you find the best available deals, anywhere in the US! Book a free call and see what the NRI team can do for you.

2. Get Pre Approved

After you find a lender, it’s time to schedule a meeting with them to talk about your specific needs, the property you wish to purchase, as well as your current financials. The purpose of this initial meeting is to get pre-qualified, which will indicate that you are in fact eligible to get a DSCR loan. 

If you are still in the process of looking for a property, you can ask the lender to give you a pre-qualification letter, which you can use to confirm to the seller (of the property you’re interested in) that you are a serious buyer. 

3. Start the Loan Application Process

After you are absolutely certain you understand all the terms of the DSCR loan agreement, you should move on to the next step – prepare all the necessary documentation and apply for the loan. The documents you will most likely need are property details and your credit history. 

And, even though not exactly necessary for this step, make sure you have enough money for a down payment, to ensure the whole process goes as smoothly as possible.

4. Wait for the Appraisal Get 1007 Rent Schedule Form

You’ll need property details and your credit score report to apply for. After you submit an application for a DSCR loan, the lender will start the property appraisal process. The purpose of this process is to determine the market value of your chosen property and figure out the fair market rent. 

The appraiser will either use the 1007 rent schedule form or, in the case of an existing lease, the lease itself, to determine the rental income of the property. While all of that is going on, your only job is to patiently wait for the numbers to come in.

5. Wait for the Lender to Calculate the Property’s DSCR

Once the figures for the rental income and property value come in, the lender can now calculate the DSCR using the formula we’ve mentioned above. But, just in case you forgot, here it is again: 

DSCR = NOI / Debt Service

Once the calculation is over, the lender will have enough information to assess your loan application.

6. Approval Process 

After the lender has the assessment in front of them, they will make a decision on whether or not to approve or reject your application. If you get approved for a DSCR loan, the lender will make you an offer that will include all the terms and conditions they are comfortable with (based on their initial assessment).

tow men shaking hands after approving a loan and closing the deal

7. Closing the Deal

If you accept the loan offer, you’ll move forward with the closing process. This involves signing legal documents, paying closing costs, and transferring property ownership.
This is the detailed DSCR loan application process, and the most crucial part is choosing the right lender to get favorable loan terms and have a smooth financing process.

NRI is a mortgage broker licensed in all 50 states!

FAQ

Can foreign real estate investors use DSCR loans to purchase investment property?

Yes, foreign investors can buy properties in the US with a DSCR loan. Unlike other types of mortgage loans, DSCR relies on a property’s rental income instead of the borrower’s credit history. This makes DSCR loans more accessible to nonresident investors.

What is a good DSCR ratio for real estate?

There’s no consensus in the real estate industry about what exact DSCR is considered to be good. But, having said that, most mortgage lenders that deal with these types of loans will look for a DSCR of at least 1,25.

How to increase the DSCR?

There are different ways to increase DSCR for real estate properties. Some of them include:

  • Increasing rental income;
  • Extending the length of the loan agreement to lower the principal amount of debt you have to pay each month.
  • Decrease operating expenses (property management fees, maintenance or repair costs, etc.)

What types of properties can I purchase with DSCR loans?

DSCR loans are exclusive investor loans, and can only be used to finance investment properties, such as:

  • Multi or single-family properties (apartments, houses, etc.;
  • Commercial or office buildings;
  • Various types of industrial properties (e.g. warehouses);

What is the minimal down payment for DSCR loans?

The minimal down payment for a DSCR loan is usually between 20-25%.

What is the minimal amount for DSCR loans?

The minimal amount for a DSCR loan is between $100,000 to $150,000, depending on the specific lender.

Start Your Real Estate Journey With a DSCR Loan

Are you searching for financing options to invest in a rental property? A DSRC loan might be the thing for you! To get a DSCR loan you won’t need W-2 forms, verifications of your personal income, or other similar things that regular mortgage loans require. But, what you’ll need is some help finding lenders that offer great loan terms.

And, that’s exactly where NRI comes in!

As a mortgage broker licensed in all 50 states, we can assist you in getting the best financing deal for your rental property. Our team of seasoned professionals will analyze your case and connect you with lenders all across the US. We’ll then help you sort through all the loan offers, compare them, and choose the one that maximizes your returns.

Luka
Founder & CEO
Luka Malkovich is a serial entrepreneur with years of experience in international real estate investing. As the CEO of Nonresident Investor, Luka’s mission is to educate foreign nationals about the US real estate market and help them secure funding and buy property in America. That’s why he’s using his expertise to turn the NRI blog into a knowledge hub for anyone interested in learning about US real estate. This article was written by a professional content writer in conjunction with Luka Malkovich. Luka has thoroughly reviewed this article and has given his final approval before publishing.

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