DSCR Loans

Cons of DSCR Loans

Difficult Loan Terms

The loan terms, such as interest rates and down payments, can be more challenging to meet than conventional loans.

Lender Fees

DSCR Lenders generally charge loan origination fees. These are additional costs in addition to the principal loan amount and interest.

Down Payment

Depending on your selected loan provider, the down payment is usually 20% of the rental property purchase price. Though some mortgages allow you to put an investment down without a down payment, this usually is not the case with DSCR loans.

Minimum Credit Score

Most lenders require a minimum credit score to grant loans, which mitigates the risk of borrowers defaulting on the loans.

DSCR Loan Requirements

There aren’t any stringent criteria that you need to meet. An advantage is that you have many lenders to choose from, each with its own requirements. So you can pick your lender as you see fit.

Credit Score

Lenders usually need a strong credit score before approving loans. This FICO score is usually 680 or above. The higher the LTV, the greater the credit requirement. 

Debt Service Coverage Ratio

This is the most important requirement. It shows lenders precisely how much of the debt can be repaid by the rental income the investment property generates.

Generally, they want at least a 1.2 to 1.5 ratio to ensure that the property can cover its payments and unexpected expenses.

Loan-To-Value Ratio

Usually, lenders accept a Loan-To-Value (LTV) of 75-80% of the investment property’s value.

Down Payment

Down payment requirements vary from 20% to 25% (though some lenders may have lower requirements). As an investor, you need to factor in this percentage of your property’s purchase price. 

Property assessment

Lenders assess the property’s income-generating potential using a comprehensive property appraisal. They evaluate factors such as rental demand, location, and existing leases. Positive cash flow is important.

Rental History

Lenders prefer to give a DSCR loan to a successful property. If it's a long-term rental, get a copy of the active lease and rent agreement. A recent gross rental payout history is needed for a short-term rental.

Maximum Loan Amount

The maximum loan amount is $1 million or $2 million. However, some confident lenders can even provide funding up to $5 million. The maximum loan amount highly depends on the investment property’s debt service coverage ratio.

How To Improve Your DSCR

To increase your chances of getting a good loan amount, here are some things you can keep in mind.

1. Increasing Rental Income

Higher rental income is a strong source of cash flow. There are many ways to strengthen rental income. Focus on continuously upgrading and improving your property to generate better income. You can also target niche markets of specific tenants.

2. Reducing Expenses

Control and reduce operating expenses to balance the equation between revenue and costs. This positively impacts the DSCR.

Undertake an extensive cost analysis. Identify areas of inefficiency, trim down insurance costs, and streamline expenses. Mitigating expenses is a surefire way to manage a good ratio.

3. Reduce Your Debt

Another method to improve your DSCR is to reduce your debt. You can do this by paying off your existing debt. If possible, you can even try refinancing your debt at a lower interest rate. For example, pay off your debt by using your cash reserves or by selling off some of your assets.

4. Higher Down Payment

A higher down payment amount can be an inconvenience at first. However, it’s a good way to boost your DSCR and a worthwhile initiative in the long run. More money down equals less debt. And less debt is always good for your ratio.

5. Better Purchase Price Negotiation

If you can purchase your investment for a lower price, you can easily boost your DSCR. Do your best to get your property at the lowest price.

Potential Risks Associated With DSCR Loans

Fluctuating interest rates

In DSCR loans with variable interest rates, changing interest rates can impact the borrower’s ability to repay the amount on time.

Other factors such as monetary policy, economic conditions, and inflation rates all impact interest rates, which may cause fluctuations in payment and repayment terms for commercial DSCR loans.

Default Risk

The biggest risk is the borrower’s failure to repay the loan, which can result in the lender losing their investment. Default risk is influenced by multiple factors, such as market volatility, the financial health of the borrower’s business, and economic downturns.

Market Risk

Financial risks posed by market conditions are an added risk. These are generally influenced by economic factors that affect the overall performance of the borrower’s business.

How To Have A Successful DSCR Loan Application

To improve your probability of application approval, here are some strategic steps you can take:

Have A Solid Business Plan

Refine your business plan to convince lenders it’s a well-defined investment. This proves the investor's ability to maintain their DSCR. Provide a comprehensive, clear account of how the loan will be utilized to generate healthy cash flow from the property.

Lenders scrutinize the following:

• Goals
• Risk tolerance
• Exit plan
• Target market

The projected cash flow has to be sustainable and consistently positive.

Provide Accurate Financial Statements

Ensure that your financial statements are organized, detailed, and accurate. This will maximize your chances of loan approval.

A property’s stable income and manageable debt levels will convince leaders. In preparing your documentation for a DSCR loan application, avoid these common pitfalls that result in rejection.

• Providing incomplete and inaccurate information
• Failing to disclose debts
• Submitting outdated financial statements

Improve Your Financial Profile

Lenders evaluate your credit score to assess your creditworthiness. A strong credit history increases your likelihood of securing a DSCR loan.

Increasing your income through additional revenue streams or optimizing your existing business operations can show lenders that you have the means to repay the loan. 

Reducing debts, especially high-interest ones, can improve your debt-to-income ratio simultaneously. A stable income and manageable debt levels are components of a favorable financial profile.

Conclusion

Having a clear understanding of DSCR loans and what factors impact your loan application is essential. Apart from empowering investors as a financing option, it carries its share of risks that are important to consider before approaching. 

These vary from situation to situation. If you’d like to know which risks and benefits apply to your financial circumstances, we are always ready to help.