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So far, throughout 2023, we have published several articles on DSCR loans, a loan product that continues to grow in popularity among real estate investors. included an overview of how to get the best rate and terms, how to use advanced strategies to maximize returns, and an overview of the new short Multifamily DSCR Loan Niche, which extends loan product for properties up to 10 units!
As many experienced real estate investors know, while investing in real estate and obtaining a loan is generally a straightforward process, there are always unique conditions and wrinkles in every deal! The BiggerPockets forum regularly features questions related to DSCR loan eligibility. This overview will help consolidate useful information for investors curious about this loan option!
This article will discuss several examples of frequently asked questions on everything related to DSCR loans and provide all the answers you need to navigate the lending process and grow your portfolio on your path to financial freedom.
1. What are DSCR loans?
DSCR loans are loans secured by residential investment properties, typically from one (single-family rental) to four units, but sometimes on properties of up to 10 units. The loans are generally originated for inclusion in securitization, either in the securitization of all DSCR loans or with other non-qualified mortgages (“non-QM”, meaning quasi-governmental agencies such as Fannie Mae or Freddie). Essential does not qualify under traditional guidelines) Mac). These loans are fully recourse to the borrower (or guarantor, if the borrower is an entity such as an LLC) and are qualified primarily based on the asset’s cash flow ability rather than the investor’s income or financial condition.
Note that “DSCR loans” should not be confused with commercial real estate loans that use debt-service-coverage ratios in their underwriting or similar products offered by banks and credit unions that may have similar products. . Those loans are classified as commercial real estate loans or “portfolio lender loans” – whereas the moniker “DSCR loan” should be reserved for this specific non-QM securitized loan product.
2. How is DSCR calculated for these loans?
The DSCR calculation, although quite basic, can be confusing to people, especially for investors with no background in commercial real estate. Why? The DSCR calculation for DSCR loans on residential investment properties is calculated by dividing the rental income of the property by “PITIA” (Principal + Interest + Taxes + Insurance + Association Dues). In contrast, the DSCR metric for commercial real estate loans is calculated by dividing net operating income (less all operating expenses on the property) by debt service (any principal and interest payments). Commercial real estate loan operating expenses typically include a number of additional expenses in addition to taxes and insurance, such as repairs and maintenance, utilities, landscaping, management fees and vacancy and credit loss estimates.
Thus, for DSCR loans, the DSCR calculated is often more favorable (i.e., higher) than expected. While it is generally smart as an investor to underwrite your rental properties on the conservative side (expected additional costs and savings in reserves), using easier qualifications on DSCR loans based on this underwriting method is a smart move. It is possible
3. Are the eligibility criteria and underwriting guidelines the same for all DSCR lenders?
No, one good thing about DSCR loans is that there are different lenders to choose from, and many have slightly different guidelines and eligibility rules. Unlike “traditional” lenders who have to strictly adhere 100.0% to the guidelines of Fannie Mae and other agencies, DSCR lenders have customized guidelines and even allow exceptions!
Typically DSCR lenders will have very similar interest rates and loan terms and the guidelines will be more or less ~90% equivalent. But the differences can be worthwhile, especially when DSCR lenders are committed to specializing in serving specific investor segments, such as those specializing in short-term rentals or the BRRRR method! DSCR lenders generally have the flexibility to make exceptions and are not required to adhere to the 100.0% (like traditional lenders) guidelines. This proves to be incredibly helpful for savvy real estate investors who make their money by finding ways to make deals a success, even if they have a few hairs on them!
4. What is the minimum loan amount for DSCR loan?
The minimum loan amount for DSCR loans will vary from lender to lender. Generally, you will likely see a minimum loan amount of between $75,000 to $150,000, although some lenders have been known to go as low as $55,000.
5. What is the minimum credit score for DSCR loan?
Like the minimum loan amount, the minimum credit score for a DSCR loan will vary (sometimes widely) by lender. Typically, the strictest lender will have a minimum of 680, while more aggressive lenders will have minimums as low as 620.
6. Can I live in the property purchased with the DSCR loan?
No, DSCR loans have very strict terms that do not allow the borrower to take possession of the properties. In fact, as part of the DSCR loan documents, borrowers are required to sign a legal affidavit certifying that they do not reside in the property or intend to reside in the property in future. This also includes specific units in multi-unit properties. So even if a property has four units (a quadruplex), and three units are occupied by third-party tenants, the fourth may not be occupied by the property owner.
7. What if it is a short term rental?
Yes, for investment properties secured by DSCR loans that are used as short-term or vacation rentals, the borrower must sign the same legal documents stating that they will not occupy the property. This involves living on the property some of the time and renting it out at other times.
However, some leniency is being exercised on them. Investors in short-term rentals with DSCR loans are permitted to stay for up to two weeks annually as long as they are in compliance with the loan documents. For vacation properties where the investor intends to spend more than two weeks a year, the DSCR loan is not an option. The good news is that “second home loans” are a widely available loan product that many lenders offer for these situations.
8. Can a first time investor get a DSCR loan?
Yes, DSCR loans are generally available to first time investors, but the rules will differ from lender to lender. While some DSCR lenders will not loan to first-time borrowers, most will, usually with minor restrictions such as having a lower maximum LTV of 5% or requiring a higher minimum credit score. However, some DSCR lenders have no restrictions for early investors, especially if the rest of the borrower has a strong financial profile.
9. What is the minimum DSCR loan down payment?
The vast majority of DSCR lenders will have a minimum 20% down payment. However, there are some who will go as low as 15%.
10. Is there a maximum amount of DSCR loan you can have?
No, unlike traditional loans, which are limited to no more than 10 properties at a time (and usually less in practice, as it’s traditionally harder and harder to qualify for once you’ve built up your portfolio. There is no maximum limit on DSCR loans as each loan will qualify based on assets and credit score, not the borrower’s personal income, expenses and total income and expenses in the portfolio.
11. Do the properties need to be leased out to qualify for the DSCR loan?
Generally, for DSCR loans that are part of a refinance transaction, the property must be fully leased to the tenant or have an operating history of generating rental income in the form of short- or medium-term rentals. For multifamily properties, some lenders will allow one or two units to be vacant for refinancing. However, these units must be “rent-ready”.
For acquisition transactions (i.e., using the DSCR loan to finance the purchase of the property), DSCR lenders will universally allow the property to be vacant but in a “turnkey” condition.
12. What are some common reasons that would make a rental property ineligible to be financed with a DSCR loan?
While each DSCR lender and some may allow or potentially allow exceptions on any of the following, these types of properties are generally ineligible for financing through DSCR loans. These are generally ineligible because the lender does not have the specific expertise needed to successfully operate the property if it is required to seize and take possession of the property. Additionally, the pool of buyers (those who have the necessary expertise) to potentially purchase a property is much smaller than the potential buyer pool for more standard residential properties.
Agricultural Properties: Properties with agricultural income-generating activities, such as farms, ranches or orchards, are generally ineligible. If you are looking at an investment property that has a main home but also includes stables or barns, it is most likely ineligible for DSCR financing, even if the income and value from the home alone is sufficient to qualify.
Assisted Living Features: Properties that are set up to provide care for the elderly (and with them high and sometimes unpredictable turnover) are also generally restricted by DSCR lenders.
Single Room Occupancy Properties: While increasing in popularity as letting tenants maximize cash flow, properties renting out by the room to tenants such as university students are generally restricted. Part of the reasoning here is that tenants under these arrangements can be more risky and less reliable than tenants who rent out the whole house.
Although DSCR loans for these properties can usually be granted on an exception basis, the property usually needs to be easily converted for use by a single tenant and if leased to a single tenant So the cash flow should be able to provide sufficient rental income.
log home: True vacation cabins, such as those in the Smoky Mountains or other rural areas, are generally restricted by DSCR lenders. However, it is also sometimes a gray area that qualifies as a log cabin compared to a single-family home designed in the “log style”. Typically, properties that are log-cabin styled, but also feature standard infrastructure connected to utilities such as HVAC, running water and a septic system, as with comparable properties in the area, are also eligible for DSCR loan financing.
Large area: Acreage limits vary by DSCR lender, but DSCR loans are generally limited to properties that are on five acres or less.
conclusion
Hopefully, this article will help you understand about DSCR loans and evaluate the investment property opportunities for which they can be best used!
This article is brought to you by Easy Street Capital
Easy Street Capital is a private real estate lender headquartered in Austin, Texas, serving real estate investors nationwide. Defined by an experienced team and innovative loan programs, Easy Street Capital is the ideal financing partner for real estate investors of all experience levels and specialties. Whether an investor is fixing and flipping, financing a cash-flow rental, or building from the ground-up, we have a solution to meet those needs.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
