Purchasing an investment property can be an excellent way to generate income and increase your cash flow. Still, it can be challenging to secure financing like traditional mortgage loans if you have little personal income.
Thankfully, Debt Service Coverage Ratio loans allow real estate investors to access a loan based on the property’s rental income rather than the borrower’s ability to pay. DSCR loans work differently than traditional loans and are specific for real estate investing, making them worth a second look for those purchasing income-generating property.
What is a Debt Service Coverage Ratio (DSCR) Loan?
DSCR loans are meant to finance investment properties and are available from a few lenders. They are typically for investors with a proven history of managing income-generating properties.
A DSCR loan will qualify based on the property’s cash flow rather than the borrower’s personal
income, as lenders assume that the projected rental income will be used to cover the property’s debts.
How DSCR is Calculated
To calculate the Debt Service Coverage Ratio, the property’s net operating income is divided by the mortgage payment and other expenses, like property taxes. This will identify whether the property has sufficient income to cover its costs and still make a profit.
Most lenders want a Debt Service Coverage Ratio of at least 1.2, though some may accept as low as 1. If the cash flow is negative, you may need to pursue a traditional mortgage loan or prove that you can make more rental income to get that ratio above 1.
Why Investors Choose DSCR
DSCR loans are an excellent option for real estate investors who may not qualify for conventional loans based on their income or who do not have perfect credit.
Those who are self-employed or rely significantly on income-producing properties may not qualify for a traditional home loan, as their application and underwriting process is skewed toward those who can prove income through bank statements. Because investment loans like DSCR loans focus primarily on potential rental income, tax returns are far less emphasized.
Finally, a real estate investor who wants to purchase multiple properties simultaneously will appreciate that DSCR loans allow them to roll multiple investment properties into the same loan. Multifamily DSCR loans can buy more than one duplex or triplex, while traditional home loans can only be used on one property.
No Traditional Credit Check with DSCR Loans
A Debt Service Coverage Ratio (DSCR) loan does not have the exact underwriting requirements as other forms of permanent financing; there is a stronger emphasis on the property’s income potential and ability to cover loan repayments.
Alternative Underwriting
Lenders will closely examine the investment property’s rental income potential, including assessing its market rent. This includes gathering details on the local market, calculating the monthly and yearly expenses, and developing the DSCR ratio.
What Lenders May Look At
Lenders will verify your assets and assess the property value, determining monthly mortgage payments. After other expenses, like property tax, are added in, the property’s cash flow will be divided by this to determine its income potential.
DSCR loans are generally only given to experienced real estate investors who have proven that they can manage rental properties, so you will need to show evidence of how any other properties you own are performing before you can get approved.
Limitations
Only some lenders will underwrite a Debt Service Ratio loan with proof of your creditworthiness. You may still have to submit personal financial information, such as a credit check, and many still require a minimum credit score.
You may also have to provide information about other debt obligations, such as your investment properties.
A unique aspect of DSCR loan terms is that you may have pre-payment penalties. This protects the lender, as those who pay off their loans immediately will not pay the high interest rates that help recoup the losses of fronting the money.
Your DSCR loan may have a pre-payment penalty for the first five years, or this may only be for the first three years. If you believe you can pay off the entire loan in just a few years, hard money loans may be a better option because you won’t have penalties for paying ahead.
Benefits of DSCR Loans with No Credit Check
Rental income loans have numerous benefits over investment loans, such as bank loans, bridge loans, or hard money loans. Regarding loan terms, they work much like a typical mortgage and have competitive interest rates compared to other options.
Accessibility for Investors
Some real estate investors may need help accessing certain loan products because they have a poor credit history or unconventional income streams, such as relying primarily on rental income.
As a DSCR loan lender is less interested in the borrower’s ability to repay the loan, investors may have an easier time being approved for these loans.
Fast Approvals
DSCR loans typically focus less on personal income verification, which makes the underwriting process faster.
Expand Your Portfolio
Rental income coverage loans allow you to roll multiple properties in the same loan, making it easier to cover your mortgage. You can also refinance current properties into that DSCR loan so that you have streamlined payments.
If the potential rental income from all the real estate included meets the requirements, you can roll up to 10 properties into the same mortgage.
What You Need to Know Before Applying
DSCR loans have their own requirements and downsides. Because the underwriting requirements differ from those for other loans, it’s important to be aware of their limitations before applying.
Potentially Higher Interest Rates
In most cases, Debt Service Coverage Ratio loans have a higher interest rate because they are riskier for lenders than conventional mortgages. This can significantly raise your monthly payments, so more of the cash flow generated goes to your debts.
Down Payment Requirements
DSCR loans typically require higher down payment requirements than other loan types. The loan-to-value ratio needs to be lower, typically 80%, though some lenders may go as low as 75%.
In most cases, the minimum down payment is 20%. Though this does mean you won’t have to pay private mortgage insurance, it can be challenging to pay for this upfront cost.
Investment Property Requirements
As the property is the most important component of getting approved for a DSCR loan, lenders take extra time to ensure that this rental is in good shape before they approve your financing.
Firstly, lenders generally have a minimum loan amount for a DSCR loan; this may be as low as $75,000, but other lenders will want higher. This is because lower-priced properties may not generate sufficient income to cover the expenses.
The property’s income is crucial. For DSCR loans, the property should be making at least 1.2 times its debts, though some lenders may accept a slightly lower ratio. If you have an underperforming property, you may have to pay a higher interest rate or a larger down payment before approval.
Location also matters because it impacts the property’s income. If you are purchasing a property in a low-income area, you may have a more difficult time accessing a DSCR loan because it will be assumed that getting tenants will be more difficult.
Finally, for a DSCR loan, rental properties should typically be move-in ready or need only light renovation. If you have a fixer-upper needing serious work, you may be better served by getting a cash-out refinance from an existing property to finance the upfront costs.
How to Find DSCR Lenders Offering No Credit Check
DSCR loans are specialized products and are not available from every lender. Typically, they are only offered by private lenders, not banks or credit unions. You can find lenders who cater specifically to investors, and you can also review online marketplaces to see if any smaller boutique firms are providing this.
Asking other investors what products they used to finance their properties can also be very helpful. They may steer you away from unscrupulous lenders or advise you on which products would be best for your specific circumstances.
Our loan officers can help you seek financing for your rentals, including DSCR loans. Simply contact us and explain what you’re looking for, and we can match you to the right options for you.
Conclusion
DSCR loans are a novel product that focuses on the income potential of an investment property rather than the borrower’s financial circumstances. They have a faster underwriting timeline and less income verification because they leverage the property’s income potential to determine whether a property is eligible.
If you’re interested in investing, F5 Mortgage is here to help. We can discuss your options and explore what loan types work best for your situation. We offer competitive rates from the best mortgage companies available. Get a free quote or check out today’s rates to better understand what you can afford.
Those ready to purchase their dream property can contact us online or call us to get specialized advice from an experienced loan officer. We look forward to assisting you in meeting your investment goals.
