Debt Service Coverage Ratio (DSCR) loans are a fantastic loan option for investors who have complicated income or have too high of a Debt-to-Income ratio for standard Conventional financing. DSCR uses the potential rental income cash flow from the property to use as the only income for qualifying. In the current rental market, where rent costs are at an all-time high and interest rates are still relatively low, historically speaking, more investors are buying homes to convert to rentals for passive income. DSCR loans allow for regular people to jump into the market and purchase rentals. While the interest rate for these programs is higher than standard Conventional, they eliminate a lot of the issues with income or debt that a regular loan would carry.
How does it work?
DSCR qualification is based on is a math formula, which takes the potential rental income and divides it by the monthly mortgage cost. If the ratio is greater than 1%, then DSCR might be the right choice for you. There is no current personal debt or income used in the calculation.
As an example:
Purchase Price: $550,000
– 20% Down ($110,000)
= Loan Amount $440,000 At 7.75% Interest
Principal & Interest = $3152.21 (Interest Only Options are available)
+ Taxes and Insurance $600
= Total Monthly Payment of $3752.21 Potential Rental Income of $4,000
$4000 / 3752.21 = a DSCR of 1.06%.
Provided the property will rent for at least $3752.21 per month, you could qualify. The rental potential is based on a current lease* or an appraisals market rent schedule (decided by the appraiser researching the current rental market for that area).
*If using a current lease, the property cannot be rented by a relative (direct or by marriage). Also there is a minimum of a 3-month receipt of rent payments.
There are minimum and maximum loan amounts needed to utilize this program. The loan amounts must be between $75,000 and $3 million. If the loan amount is under $1 million, the minimum amount of reserves, the amount of liquid cash available after all closing costs, would be 6 months of the total monthly mortgage payment. If the loan amount is above $1 million, that reserve requirement jumps to 12 months.
The minimum credit score requirement for this program is 680 and minimum down payment is 20%. Although more favorable pricing for +25% down and/or higher credit scores. As this program uses rental income as its main basis for qualifying, DSCR is ONLY for investment properties. The property must also be zoned as residential and maximum number of units is four.
Unfortunately, this program relies heavily on the appraisals rent schedule; therefore, it’s challenging to know if a DSCR loan will meet borrower needs at the onset. Working with a real estate agent familiar with the area PRIOR to going under contract and ordering an appraisal as quickly as possible to ensure rental income meets this program’s guidelines are both very advisable practices with this type of financing.
DSCR loans are ideal for investors who have multiple rental properties already which may complicate their Debt-to-Income ratio yet want to further grow their investment portfolio. To see if you qualify for a DSCR loan or if you have additional questions about this new program, contact your mortgage loan professional.