Despite shifts in the market, real estate remains one of the best ways to build your investment portfolio, especially due to its flexibility. There are countless ways to invest in real estate, from the safe and hands-off REIT to truly diving in and becoming a landlord; you can match these to your own budget and level of risk.
As with other business ventures, most of those investing in real estate take out business loans, but not any loan will do: you need one especially geared to property investments, a type of mortgage that recognizes profit margins and doesn’t necessitate a deep dive into your finances.
This is why investors have capitalized upon a certain species of mortgage, one made solely for real estate investment: DSCR home loans. This compact guide will examine why DSCR loans benefit investors, how they work, and why property conditions are the most crucial to securing this unique loan type.
How Do DSCR Loans Differ From Other Mortgages?
The traditional mortgage is designed for owner-occupied properties: lenders for these loans are primarily interested in your creditworthiness and ability to pay back your loan based on your own financial circumstances. As such, they focus intently on your debt-to-income ratio, financial history, and income rather than truly investigating the property itself; they view the property not as a profit-producing product but as a personal investment to be held for the long term.
In contrast, DSCR loans are entirely geared toward real estate investors, recognizing that the purchase is meant to develop a profit rather than simply be held and lived in. As such, they look more at the property’s history and income potential instead of the borrower’s financial circumstances.
Loans for Foreign Nationals and Corporations
Another reason that DSCR loans are popular for investors is that, since they’re not concerned with tax returns and pay stubs, they are more amenable to foreign investors than a traditional mortgage. Some foreign nationals may be denied a traditional mortgage because they cannot show W2s and 1099s – they don’t have these. However, most states don’t have a prohibition on foreign investment: it’s only the lenders, who want to see employment history, that will deny a borrower. DSCR loans are different thanks to their minimally-invasive investigation of a borrower’s history.
The last reason why investors prefer DSCR loans is that they can be taken out under a corporate entity’s name rather than underwritten in a person’s name. To avoid entanglements with personal finances, corporations choose to seek DSCR loans for their investments, thus ensuring that they can’t have their assets seized if there is a concern with the property.
The Debt Service Coverage Ratio
Of foremost interest in securing a DSCR loan is the Debt Service Coverage Ratio. This ratio divides the property’s rental income by its debts to identify its profit margin. A positive number indicates that the property is making money, while a negative number shows that it is a money sink: you spend more than you get back.
To identify the DSCR, your lender will examine documents regarding the property’s previous tenant history, including lease agreements, to see how much money it is making per year. This will be supplemented by rent schedules, which assess the market rents in the area to calculate the potential income. Lastly, the rent schedule will then be divided by the mortgage payment, which is determined by the property value and the mortgage terms, including its interest rate.
This focus on DSCR frees you from needing to provide a great deal of personal financial documentation, making these loans an excellent option for those with nontraditional income like self-employment. While you may be denied a traditional loan based on this, given that the DSCR is mostly concerned with how well the property performs, all you really need to provide is your credit score, basic identifying information, and the down payment.
Choosing a Suitable Property for a DSCR Loan
While profit margins are important for any business venture, they are the deciding factor in whether to purchase a property with a DSCR loan. You need to be able to prove that you will be able to satisfy the loan and make income by calculating the DSCR ratio; you want to aim for a 1.25 ratio, though some lenders will be satisfied with a 1 should you need to perform some rehabilitation on a property before boosting your profit.
As such, you must perform careful research on the property, including its current value, rental income, and future earning potential, before choosing to purchase it. Should you see a property with promise that doesn’t currently satisfy the ratio, consider how you can boost its earning potential by submitting a business plan, which will outline how you intend to raise rents within current market conditions and what improvements will be able to justify the increase. To lenders, this will be the impetus they need to approve your loan.
Real estate investment is a solid idea, but traditional mortgages don’t necessarily provide the flexibility and profit-focused funding that borrowers need. DSCR loans, in contrast, afford investors loans based on profit potential rather than their own financial circumstances, making them a clear winner in the world of real estate business loans.