Let’s chat about the Debt Service Coverage Ratio. First, it’s known on the streets as the DSCR, so if you want to ask about this, make sure you keep it real and refer to it correctly.
Next, the DSCR is fundamentally a ratio. You probably guessed that since the “R” stands for ratio. The equation itself takes monthly net operating income and divides it by expenses. The idea is that if the score is above 1, this shows that a person is making more than they are spending. Lenders can use this ratio for someone seeking a loan for things like an investment property.
You’re probably thinking “ok Phil, when do we get to the examples?”. That answer is: now.
We hear at all at A Nightmare on Loan Street Blog. I wanted to share a couple of great examples of situations where the DSCR might be a good option for an investor.
Case #1: Wow, someone cooks drugs here
This one guy details in full a property he wanted to flip. From the outside, it looks pretty nice. Homes in the neighborhood are going for $2M, but this home was listed for $1.25M. He gets inside, and the place is a total mess. Drywall is missing. Appliances are gone. There are pipes, cables, and beakers strewn about. He understands the price and thinks “wow, someone cooks drugs here”. This can be trouble for a flipper because it likely won’t appraise for the right value.
Case #2: Look at this photograph
Another investor wrote about a similar nightmare property. Again, the neighborhood has $1M homes, and the outside looks nice (you’ll notice a theme that the outside looks nice). But this house was going for $600k. As soon as this guy gets inside, he sees why. The seller is a huge Nickelback fan. There was a mural of Chad Kroeger in the foyer. The lyrics to Rock Star are written on every wall…in lipstick. Of course, no bank is going to touch a place like this. It is a tough job for any flipper.
For these investors, they had a choice of a hard money loan or a DSCR loan. The hard money loan would have higher fees, and the loan would be based on the post-renovation value of the home.
The DSCR loan fees are about 3-4% lower than the hard money loan, and the lender is only looking at the investor’s ability to make the payments based on the DSCR score.
The DSCR option means that investors can have more capital on hand to cover those unexpected costs, or more cash available for another property compared to the hard money option. The bank only cares if they can cover the payment on the property with the DSCR loan. That’s it. Checkout this DSCR calculator to run your scenarios.
If you have a similar experience with a nightmare flip, we’d love to hear about it. Maybe we’ll even feature you on A Nightmare on Loan Street Blog. Until then, if you have questions about the DSCR or think this might be an option for you, give the team at Truss Financial Group a call. Tell them Phil said “look at this photograph!”.
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