From seasoned investors to people who want to purchase their first income property, a DSCR loan could be the right option.
Standing for “Debt-Service Coverage Ratio,” a DSCR loan doesn’t use the documents that are typically used in loan applications. Instead, these loans look at only two important factors to make a lending decision.
These two factors are 1) how much income the property will bring, and 2) how much the mortgage on the property will cost. If the numbers look good, if the debt-service coverage ratio (DSCR) is positive, then you have a solid chance of being approved for the loan.
What is a DSCR Loan?
When you want to secure financing for your next investment property, a DSCR loan can be an extremely important option, one that may bring financing when other loan options are exhausted. Real estate, of course, brings a wide variety of benefits. It comes with plenty of risk, but when properly managed an investment property can be an asset that not only brings a regular income but also grows in value. Not all real estate purchases pay off, but there’s no doubt that it can be one of the best investments possible.
A DSCR loan is simply another option for purchasing an investment property.
Purchasing an investment property can be difficult. With stocks, mutual funds, and other investment opportunities, you can take a few thousand dollars, even a hundred or less, and invest it in the market. With real estate, unless you join an investing group, you’ll need hundreds of thousands, possibly millions, to make the purchase. Most people simply don’t have the resources to purchase investment property, so they use loans to make it happen.
But loans for investment properties are unique. Compared to a loan for a personal home, there is more risk when lending against an investment property. Investment properties are treated, appropriately, as an investment. This is unlike a typical home loan, which has a significant emotional attachment from the borrower. Think of it this way: if a borrower can only make one payment, which will they pay, the loan on the family home or the loan on the investment property. Most people would put the investment property at risk before they risk losing the roof over their family’s heads. This is the fundamental reason that investment property loans have higher requirements.
To use an investment-property loan, your income may not be enough and your debt load may be too high. If this is the case, a DSCR loan could be a solution.
The debt-service coverage ratio is simply a statement of the ratio between the monthly rental income and the monthly cost of owning the home. If the ratio is positive, you have a good chance of securing the loan.
Here’s an example: Let’s imagine you are looking at a property that, when purchased with a mortgage, would have annual cost of $36,000, which is equal to $3,000 a month. If you were to purchase the property, you would be able to bring in an annual income of $48,000, which is equal to $4,000 monthly. In this simplified example, the DSCR is 25%, meaning the property generates 25% more than the total cost of the mortgage. In this situation, you have a positive cash flow, so you are more likely to reach approval with a DSCR mortgage.
From the lender’s perspective, there is less risk when the ratio is higher. Purchases with a 50% DSCR ratio, for example, stand a high chance of reaching approval.
Why Use a DSCR Loan?
No Personal Income Documents
When you use a DSCR loan, you won’t have to bring all the income documents that are usually required. These loans focus on the cash flow of the investment property, not your personal finances, so mortgage approval can be swift and easy.
When you use a DSCR loan, you get rid of the need for paystubs and tax returns. From an investor’s perspective, this can be highly beneficial. For investors, pay stubs and tax returns may not provide an accurate reflection of their total finances, so the documents may not be useful for approval.
Close in a Company Name
Using a DSCR loan, you can close the mortgage in the name of a company or LLC. There are numerous advantages to this approach, and it helps create a separation between your personal finances and the investment property.
Low Upfront Costs for a Large Investment
You don’t have to be a millionaire to use DSCR loans. You don’t have to have hundreds of thousands of dollars in available capital to make the purchase, which is one of the reasons many people avoid investment property. With DSCR loans, you may be able to complete the purchase with a minimal downpayment. In many cases, a 20% downpayment should be enough to secure the loan.
Generate Cash Flow
Other investment gain value, and property certainly has its risks. A property purchased with a DSCR loan, however, can bring a steady flow of income that enhances your monthly budget. You could bring in more money for future investments, college savings, retirement, or simply to improve your lifestyle.
Tax Benefits
Property investment is often a longterm game. It’s (usually) geared towards making a profit over decades, not a couple of years. However, if you decide to sell, you may realize profit, which means you’ll have to pay taxes. But there are tax credits that are available to property investors who purchase low-income housing. If you purchase properties that could be used as low-income housing, you may enjoy a variety of tax benefits that make your property even more beneficial.
Find the Loan You Deserve to Build Your Investments!
If you want to learn about DSCR loans in San Diego, contact our staff today. We’ll explain how they work, and help you prepare to use these loans on your next mortgage. When you need an affordable loan to build your investment portfolio, work with our experienced, knowledgable team.
