8 More Frequently Asked Questions and Answers on DSCR Loans

So far, throughout 2023, we have published several articles on DSCR (Debt Service Coverage Ratio) 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 for maximum return, and an overview of the new Small Multifamily DSCR Loan Niche, which extends loan product for properties up to 10 units! In May, we posted 12 frequently asked questions (and answers) about DSCR loans., It proved to be very popular and helpful for real estate investors searching for this transformative loan product.

More questions and advanced scenarios keep coming and being discussed bigpockets forumThat’s why we decided to publish another installment to cover more of your questions!

1. I am not a US citizen. Can I qualify for a DSCR loan?

This is a question that will vary from DSCR lender to DSCR lender, but it is highly likely that you will find someone who can lend to you. One of the challenges in qualifying as a foreign national is the lack of a credit score, which we’ve covered here. earlier articleForms one of three key metrics (along with LTV and DSCR ratio) to determine eligibility, rates and terms.

In addition, DSCR lenders typically require “reserves” in liquid assets (usually cash accounts) or a few months’ PITIA (principal + interest + taxes + insurance + association dues) payments, and many foreign nationals have These assets are not denominated in US dollars. Some DSCR lenders, however, will allow foreign nationals, but typically come with restrictions on the LTV (typically limited to 65% instead of the usual maximum of 80% under most DSCR programs) and a requirement for US-based. Bank accounts for reserves.

Finally, it is important to note that this applies to true “alien citizens” who are non-US citizens living abroad. Both resident aliens and non-resident aliens (i.e., “green card” holders) are generally fully eligible for DSCR loans without any LTV restrictions. Furthermore, one of the main advantages of DSCR loans is that borrowers are allowed to be entities such as LLCs, partnerships or corporations. Typically, if you are a foreign national who owns a portion of an LLC or entity with US citizens, and your partner owns at least 50% of the entity and signs a full recourse guarantee, you will be eligible for the DSCR loan. Must be able to qualify for. No restrictions.

2. Can I buy a property with a DSCR loan and pay the down payment with seller financing or any other loan?

Generally, the answer to this question is “no”. Almost all DSCR lenders will not allow any other liens to secure the investment property you are purchasing or refinancing. Part of the benefits of a DSCR loan is that the lender only evaluates your credit and the mortgaged property, not your global cash flow, or DTI. This means that unsecured loans or mortgage loans on other properties in your portfolio will not jeopardize the financing. However, any additional debt related to the property you are securing with your DSCR loan is prohibited.

While some DSCR lenders will classify as “no ratio” everything with a DSCR less than 1.00x, some will separate out loans with DSCRs around 1.00x as eligible and ratios with DSCRs between 0.75x and 0.99x. Will be the ones. These lenders will refer to any DSCR loan with a DSCR less than 0.75x as “no ratio”.

3. How much reserve do I need for DSCR loan?

“Reserves” in the context of DSCR loans refer to the documented liquid assets held by the borrower at the termination of the loan. Typically, DSCR lenders will require around six months of PITIA reserves to be documented. This gives the lender the added convenience that in case of interruptions in cash flow from the property (such as vacancies from leasing turnover or holidays or slow seasons for short-term rentals) the monthly payments will be borne by the borrower. Lender requirements typically range from a minimum of three months (or sometimes a full waiver for specific scenarios such as a rate-term refinance to lower monthly payments) to nine or 12 months (for very large loans or additional loans). may be required). with DSCR less than 1.00x).

4. Can I use my investment or retirement accounts to fund my need for reserves?

Yes! Most DSCR lenders will allow the use of brokerage accounts (stocks and bonds) and even retirement accounts such as 401(k)s to meet the reserve requirement. While they will be allowed roughly the same amount, the lender will typically use a “haircut” on these balances, meaning they will reduce the amount by 10 to 20% that matters. For example, a DSCR lender might give you a credit of $80,000 in reserves for a 401(k) retirement account with a portfolio value of $100,000.

Why do DSCR lenders use this “haircut”? This takes into account the higher risk of stocks and bonds versus cash (these values ​​can fluctuate, while cash remains stable) and lower liquidity (or the borrower’s ease of access to funds). . For example, if a borrower actually needed to use retirement funds to pay debt service on a DSCR loan, it would likely take time and cost for them to sell financial instruments, transfer funds, and May be liable for a fee.

5. Can I use bitcoin or other crypto assets for the reserve requirement?

Generally, most DSCR lenders will No Allow digital assets to be used for reserve requirements. However, this is a space that is still very new and constantly evolving, and a bitcoin and crypto-friendly DSCR lender currently exists!

6. What is a “No Ratio” DSCR loan?

A “no ratio” DSCR loan generally refers to a DSCR loan that has a DSCR ratio (rental income divided by PITIA) less than 1. This is a bit of a misnomer because if the ratio is less than one (eg 0.85x), that ratio can be calculated and does exist, but it is still usually referred to as “no ratio”. will be referred to.

7. Can I qualify for a DSCR loan if my ratio is less than 1.00x?

Yes! While a DSCR loan with “no ratio” may seem like a contradiction, it is not a barrier to qualifying for many DSCR lenders! Many lenders that allow loans with ratios less than 1.00x will typically require a minimum of 0.75x or 0.85x. However, there are also some lenders that will allow true “no ratio” DSCR loans without limits, even as low as 0.75x!

8. Why would anyone invest in a property with a DSCR ratio of less than 1.00x if it meant losing money every month?

believe it or not, there are multiple positions Where it makes sense for both the investor (borrower) and the lender to enter into deals that have a DSCR of less than 1.00x!

One example is for markets that have really high appreciation due to limited supply, rapid growth, or other factors. Historically, these markets, such as those in coastal California or Austin, Texas, have generated huge returns for investors through increases in home prices that far exceed any modest negative cash flows. However, it is impossible to predict the future, and there is no guarantee that those markets will still earn appreciation returns significant enough to make them profitable investments overall.

However, from the lender’s perspective, at a low enough leverage point (typically 65% ​​LTV or less), it makes sense to lend at a sub-1.00x DSCR to borrowers who want to gamble on appreciation, because if they default If you do, there will be less chance of the lender losing money because the foreclosure will cover the potential loan loss.

Additionally, there are other scenarios where a sub-1.00x DSCR makes sense for an investor “on paper”. One of the main features of DSCR loans is that they are usually fixed-rate and fully amortized over 30 years. This means that the biggest expense on your rental property, the monthly loan payment, will be fixed for three decades. However, market rents typically increase every year, including staggered increases Rents increased by 145% (from $447 to $1,096) over the 30-year period between 1990 and 2020! While taxes and property insurance rates are also increasing, the monthly cash flow of a property held for 30 years and financed with a fixed-rate DSCR loan will increase massively as rental income increases, keeping loan costs the same. Lives Thus, investors with a long-term horizon are likely to get great returns even if they have negative cash flow in the first few years, which will be balanced out by the increase in market rents over time.

In addition, many real estate investors use the tried-and-true strategy of targeting properties, in which tenants pay rent below market, and then once the property is purchased, the rent is pushed back to market when the lease expires. Let’s increase However, DSCR lenders underwrite the DSCR using Lower of local rent or market rent, Hence, the DSCR on these properties can be negative if the rent is much below the market rate. In this case, these deals make a lot of sense to investors as they usually only have to wait a few months (out of a 360-month period) for the property to re-rent and start cash flowing. Here is another example of a “no ratio” DSCR loan that is “no ratio” only on paper and will provide cash flow and solid returns.

The flip side is if a property is rented out at a rental rate significantly above the “market rent” determined by the valuer. In this case, the DSCR lender will still use the Lower of in-place rent or market rentThis is creating a situation where the underwriter’s DSCR may be less than 1.00x, but the rent checks that come into your account each month tell a different story!

Finally, there are situations where DSCR lenders are still extremely cautious when it comes to lending on vacation rentals or short-term rentals. A common method for these less forward-looking lenders is to underwrite the DSCR based on the market rent the property would earn as a long-term rental, regardless of whether it is optimized for short-term occupancy or in a vacation market dominated by short-term rentals. . , In these cases, the underwritten DSCR may be less than 1.00x, but in the real world, the asset will generate stronger cash flows than the PITIA costs. Another case of understanding for both parties to make a deal despite “no proportion”.

conclusion

Hopefully, this article will help you understand about DSCR loans and evaluate the investment property opportunities for which they can be best used!

Note by BigPockets: These are the views expressed by the author and do not necessarily represent the views of BiggerPockets.