For years, residential real estate investors have purchased investment properties in the name of limited liability companies (LLCs). By establishing an LLC, investors receive protection from lawsuits while keeping their investment business separate from their personal affairs. Historically, traditional avenues for securing loans, such as through banks and credit unions, were the best option for investors looking to secure loans for 1 to 4-unit rental properties. That is, until recent developments surrounding debt service coverage ratio (DSCR) loans.
Following the COVID-19 pandemic, real estate prices skyrocketed while interest rates plummeted. DSCR loan prices have become competitive with traditional lenders. With more flexibility and financing speed, DSCR mortgage loans have taken the real estate market by storm and become the preferred choice of rental investors.
But what are DSCR loans exactly, and are they the best option for you? Let’s dive in.
DSCR Loans Explained
Most real estate investors with LLCs are “self-employed.” Without a W2, securing conventional financing for investment properties can be extremely difficult. Traditional lenders require at least two years of steady employment and income to even consider applicants.
DSCR Loan Calculator
DSCR loans for LLCs, on the other hand, do not focus solely on an investor’s personal income and don’t require any tax returns for approval. DSCRs use a DSCR formula to determine a loan’s eligibility based on a property’s rental income (in-place or potential) and the investment’s principal, interest, taxes, property insurance, and association dues or “PITIA.”.
DSCR Formula = Rental Income / Principle + Interest + Taxes + Insurance + Association Dues
This formula determines the DSCR ratio, which identifies the profitability of a property (rental income) based on its overall expenses (PITIA). So, if your investment rental property has a net operating income of $100,000 per year and its combined PITIA is $50,000, your property has a 2.0 DSCR ratio.
What is a Good DSCR Ratio?
A 1.00 DSCR ratio indicates your property will break even. While some investors are more than happy with breaking even–since the mortgage payments will eventually disappear–it leaves little to no room for errors.
For investors looking to scale their business, the higher the DSCR ratio, the greater the profit and potential loan amount. Mortgage brokers financing the investment want to ensure the loan is eventually repaid, and a higher DSCR gives brokers the peace of mind to approve higher loan amounts. Investors should look for rental projects with a 1.25 DSCR or higher to ensure profitability and approval.
DSCR Loans Pros & Cons
DSCR loans have permeated the real estate rental market because of their financing flexibility and sensibility. Let’s look at the few downsides and the many benefits of DSCR loans that make them so attractive to investors:
DSCR Cons
- Credit Authorization: Unlike certain business loans, DSCR lenders may require a hard credit pull and a credit score of at least 620 to qualify. However, some lenders (like Roc Capital) offer soft credit pulls, which won’t affect your borrower’s credit score.
- Down Payment: While in certain unique circumstances, DSCR loans with no downpayment have been approved, most lenders require a downpayment of at least 15 to 20% of the loan amount.
- Strictly Long-Term Investments: DSCR loans are not available for investors looking to flip or convert a property into their primary residence.
DSCR Pros
- No Personal Income Requirements: As mentioned, many investors operate self-employed businesses under LLCs, making it difficult to prove income for traditional loans. DSCR loans consider a property’s current or potential income throughout the loan process–making it easier for lenders to say “yes.”
- Less DSCR Loan Requirements: Unlike conventional loan applications, DSCR loans have significantly lighter documentation requirements. Without the need for W-2s or 1099s, applicants are typically only required to provide:
- Two months of bank statements showing 3 to 6 months of liquid reserves to cover debts in the case of vacancy, turnover, etc.
- Occupant lease(s) (if applicable)
- Insurance (property, flood, tornado, fire, liability, etc.)
- Renovation documentation–receipts, invoices, or work orders regarding any rehabilitation work on the property.
- No Penalty for Tax Write-Offs: While tax write-offs are essential in real estate investing, each write-off reduces an investor’s taxable income–making them less desirable in the eyes of conventional lenders. However, private lenders offering DSCR loans can ignore taxable income altogether, making it easier for investors to get approved.
- Fewer Restrictions From Private Lenders: Since the 2008 housing market crisis, governmental and institutional oversight for traditional mortgages has ramped up. While these provisions have helped protect homebuyers and the market, it has significantly hindered real estate rental investors by:
- Further slowing application processes
- Limiting how much capital investors can get for a loan
- Restricting the number of loans an investor can have at one time
- Making loan approval more difficult for both lenders and borrowers
Traditional lenders’ lack of flexibility and speed impede investors’ ability to scale their businesses. DSCR loans through private lenders, on the contrary, are widely praised for their flexibility and sensible underwriting processes.
DSCR Loans Through Private Lenders
Unlike traditional lenders who are forced to navigate loan application approvals through the lens of previous income, private lenders have the flexibility to help real estate rental investors grow their profits and business. By leveraging DSCR loans and the DSCR loan formula, taking into account a property’s current or potential rental income and DSCR ratio, private brokers provide a more sensible application process–with more opportunities to say “yes!”
Significantly less institutional oversight, better DSCR loan requirements, and the freedom to tailor financing options to meet borrowers’ unique needs make DSCR loans through private lenders the ideal financing avenue for real estate rental investors.
Roc Capital: Helping Mortgage Brokers Scale
To grow effectively, mortgage brokerage businesses must have opportunities to say “YES” when conventional avenues can’t. DSCR loan options through Roc Capital provide lenders with reliable and flexible financing options to meet the needs of their borrowers.
Roc Capital’s Rental Portfolio and Single Property Rental programs offer:
- DSCR blanket loan with no W2s, paystubs, or tax returns required
- Competitive 30-year term loan options
- Maximum rental flexibility
- SFR, warrantable condos, townhomes, PUD, and 2-4 units eligibility
Want to partner with the most reliable DSCR l capital partner in the industry? CLICK HERE to schedule a FREE consultation today!
