Are DSCR Loan good?
New to Real Estate · Tampa, FL · Member since 2023 · 4 posts · 13 votes
Are DSCR Loan good?
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Lender · Austin, TX · Member since 2022 · 474 posts · 586 votes
3yCarlos, it depends on your situation. Generally speaking, if you can qualify for conventional financing then that's the cheapest debt option and makes the most sense. If you continue to scale your portfolio, you will reach a point at which conventional financing is not an option (due to DTI or 10 loan Max per Fannie and Freddie) and then DSCR is typically what investors "graduate" into.
There are lots of pros to DSCR loans (vest loan to LLC, lighter underwriting, quicker turnaround time) but generally makes sense to go conventional route until you can't anymore.
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- Investor · Mishawaka, IN · Member since 2014 · 48 posts · 22 votes3y
They can be a great tool to use if you don't qualify for full doc investment loan. The downside is that the rates and fees tend to be higher which can eat into your cash flow.
- 3yJohn O'LearyPro MemberLender · Winter Park, FL · Member since 2021 · 738 posts · 412 votes
DSCR loans do not report to credit agencies nor do they use tax returns, or income verification to qualify. As @Micah Cook mentioned, the rates are slightly higher but if you are solely focused on cash flow, or your cash on cash return you may be able to buy the rate down and roll the buy down points into the loan. Another reason to consider a DSCR loan is if your local banks have tapped you out due to exposure limits.
- Lender · Austin, TX · Member since 2022 · 474 posts · 586 votes3y
Carlos, it depends on your situation. Generally speaking, if you can qualify for conventional financing then that's the cheapest debt option and makes the most sense. If you continue to scale your portfolio, you will reach a point at which conventional financing is not an option (due to DTI or 10 loan Max per Fannie and Freddie) and then DSCR is typically what investors "graduate" into.
There are lots of pros to DSCR loans (vest loan to LLC, lighter underwriting, quicker turnaround time) but generally makes sense to go conventional route until you can't anymore.
- Lender · CO CA TX WA ID OR · Member since 2020 · 419 posts · 542 votes3y
Quote from @Carlos Ortiz Perez:
I heard recently about DSCR loan's. What's your opinions about this type of loans? Should I consider using this loans?
Hi Carlos. I suspect you are newer to this space and may be alarmed when you hear that DSCR loans are much more expensive than what you are familiar with when compared to regular loans.Here's a scenario to illustrate why people use DSCR loans instead of regular conventional (or other) loans.
1. When you have a regular W2 job, you pay taxes on your income. Ex. you make $100k per year and taxes take about $30k off of that. Simple and clean.
2. When you have investment properties and rental income, you can minimize your tax burden by writing off expenses, interest, repairs, and depreciation, thus making your "income" very low and you are taxed much less as a result.
3. Now, conventional, FHA, VA, and USDA loans qualify you to purchase home based on your income. As a regular W2 earner, it's easy to calculate your purchasing power: Your monthly gross income vs your monthly debts. But what if you have rental property income only? Remember, we want to show as little income as possible because we are writing off those expenses, interest, repairs, and depreciation. Think you will qualify for a regular conventional, FHA, VA, and USDA loan? Not a chance.
4. This is where a DSCR loan is used. DSCR = Debt Service Coverage Ratio. This is a formula that determines the performance of a specific asset. This IS NOT an income-based loan. As a result, do not compare the rates of this loan to regular loans.
The formula is (simplified version):
Cost of the loan (Debt Service) = $1000/mo
Revenue from the property = $1000/mo
Therefore, the Revenue / the Debt Service = $1000 / $1000 = 1.00
Lenders typically like to see a 1.20 ratio or above. They will go lower, especially if an investor is going to improve the property to get it performing, but a lower DSCR ratio results in a higher rate because it is riskier.
5. Now that you know the ratio and the tax implications, understand this:
In order to continue to use financial products to mortgage properties, there is a trade off on that rate. You are receiving the benefits of paying substantially lower taxes due to your reduced income. As a result, you can used an asset-based financial product (DSCR loan) to get you the property you want while still paying lower taxes. This is why the rates are higher.
I hope this clarifies how DSCR loans work and why people use them even if interest rates on them are in the double digits.
- Member since 2023 · 303 posts · 324 votes3y
Conventional financing does come with lower rates/fees, but DSCR loans do have several distinct advantages over conventional financing. DSCR is primarily qualified based on the asset and also the investor's credit.
For one, DSCR loans don't take into account DTI, which is particularly advantageous for those that are looking to scale their investment portfolios given that by the second or third property, qualifying based on debt to income ratio becomes much more difficult.
No tax returns are required during qualification, either. You can borrow through an LLC, you have access to more than the ten loan limit on conventional financing, and the loan size that you can acquire has a significantly higher maximum. It's also a significantly more flexible process as far as qualification and underwriting.
- 3yDoug SmithPro MemberLender · Tampa, FL · Member since 2013 · 2k+ posts · 2k+ votes
DSCR loans are good if they wear White Hats. If they wear Black Hats, they are villains. A DSCR loan is simply a tool...neither good or bad. If it works for your situation, then great. You simply need to understand what they are and what benefits or drawbacks they have. They will typically be a bit higher in rate then a Fannie/Freddie Loan and most will have prepayment penalties, but they also only cash flow the property instead of doing a "global cash flow" like Fannie and Freddie do. You can scale with DSCR loans where it's tough to do with Fannie/Freddie. With rates a bit higher than they were last year, I don't recommend to our customers that they max out the LTVs to get a better long term cash flow (in other words, I recommend putting a bit more down that the minimum), but they can be great tools if used properly...and not so great it you don't.
- 3yAlex BekezaBusiness MemberLender · Los Angeles, CA · Member since 2018 · 2k+ posts · 1k+ votes
They're a no brainer for any investor looking to scale beyond the limitations of Fannie/Freddie, find cash out with short seasoning, vest title in a LLC, have a non DTI based approach etc. etc.
Investor Property Loan5307 Reviews - 3yDevin PetersonBusiness MemberLender · Sarasota, FL · Member since 2022 · 2k+ posts · 682 votes
Quote from @Doug Smith:
DSCR loans are good if they wear White Hats. If they wear Black Hats, they are villains. A DSCR loan is simply a tool...neither good or bad. If it works for your situation, then great. You simply need to understand what they are and what benefits or drawbacks they have. They will typically be a bit higher in rate then a Fannie/Freddie Loan and most will have prepayment penalties, but they also only cash flow the property instead of doing a "global cash flow" like Fannie and Freddie do. You can scale with DSCR loans where it's tough to do with Fannie/Freddie. With rates a bit higher than they were last year, I don't recommend to our customers that they max out the LTVs to get a better long term cash flow (in other words, I recommend putting a bit more down that the minimum), but they can be great tools if used properly...and not so great it you don't.
That intro was the laugh I was waiting for all day long. Glad it was you who provided it!
ProAlpha Capital55 Reviews - Lender · Allentown, PA · Member since 2023 · 207 posts · 38 votes3y
Hey @Carlos Ortiz Perez,
I have helped plenty of people purchase/refi into DSCR products. It solves a problem for them. Maybe they don't have a sufficient income source, or they are stuck on the limit of how many properties they can finance with conventional investment. DSCR also tends to be an easier process as well. STR, MTR or LTR, these are great products to look into. I would be happy to hear more about what you're looking to accomplish.
- Realtor · Charlotte, NC · Member since 2023 · 245 posts · 231 votes3y
I think it depends on your situation. DSCR loans (at least when closed under an LLC) don't show up on your personal credit report, don't affect your DTI and can be advantageous in certain scenarios. For example, if you're self-employed, have the max amount of conventional loans out or you are maxed out on your DTI.
However, the rental comps need to cover at least the mortgage payment. That's the biggest obstacle some of my buyers are going through right now with these higher interest rates. DSCRs are also very expensive. Points are higher and rates are higher.
Generally speaking, if you are able to qualify with a conventional loan, I'd go that route. If not, DSCR is a great solution.
- Investor · Orange County, CA · Member since 2014 · 363 posts · 408 votes3y
Quote from @Carlos Ortiz Perez:
I heard recently about DSCR loan's. What's your opinions about this type of loans? Should I consider using this loans?
Loans aren't good or bad. There are loans that fit the property/investors and there are loans that do not.
DSCR laons are a great loan product for rental properties that are cash-flowing well and for investors that don't qualify for conventional.
Just be sure the property's income can support the higher interest rate.
- 3yStacy RaskinBusiness MemberLender · Member since 2022 · 1k+ posts · 530 votes
DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth.
Here's a bit more in detail about how rates are calculated for DSCR loans:
1. Credit score- the higher the best. 760+ generally gets best pricing for investment property loans with most lenders
2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.
3. Prepayment penalties- usually 1-5 year terms. The shorter the prepayment term has an impact on increasing the rate.
4. Are you cash flowing the property? Is your DSCR ratio greater than 1-meaning are you cash flowing. Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit.
I've included an example below to help illustrate this.
So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.
See example below:
DSCR < 1
Principal + Interest = $1,700
Taxes = $350, Insurance = $100, Association Dues = $50
Total PITIA = $2200
Rent = $2000
DSCR = Rent/PITIA = 2000/2200 = 0.91
Since the DSCR is 0.91, we know the expenses are greater than the income of the property.
DSCR >1
Principal + Interest = $1,500
Taxes = $250, Insurance = $100, Association Dues = $25
Total PITIA = $1875 Rent = $2300
DSCR = Rent/PITIA = 2300/1875 = 1.23
DSCR lenders generally let you vest either individually or as an LLC. It's a great way to increase your net worth and these loans can also be used to pull cash out of a property as it appreciates allowing you to reinvest money into new deals.
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