It’s no secret that the real estate market has always been considered very financially lucrative. This is why rental properties are such a common investment and why so many people are trying to toss their coin into the pot of real estate. New constructions are being built every year, whether it be new buildings for apartments or condominiums, or entire suburbs.
Housing is currently in very high demand, and that isn’t expected to change anytime soon. Shelter will always be a necessary commodity, which is why, if you’ve been looking for a smart way to start investing in your future, then real estate could be exactly the opportunity that you’ve been searching for. It might seem intimidating at first, but with a DSCR loan to get you started, you can make your money work for you.
How You Qualify For a DSCR Loan
A DSCR (Debt Service Coverage Ratio) can help you determine how well your net cash flow will cover your mortgage. It is a tool used by lenders to determine the maximum loan amount that an investor qualifies for. The way that it is calculated is really quite simple.
The ratio is measured by dividing your property’s NOI (annual Net Operating Income, generated through rent) by its annual debt service; which includes your mortgage, interest, and any principal costs. The ratio that you are given from this equation lets you know what percentage of your net operating income covers your annual debt payments. The higher your ratio, the better your profit, and the more likely you are to be approved by lenders, who typically seek a DSCR of 1.25 or higher.
Different lenders have different financial requirements for DSCR loan approval. DSCR loans don’t require W2’s to be provided for approval–making them the ideal loans for self-employed real estate investors–but the majority of lenders will still want to see recent bank statements to provide proof of income, that way they know you have the ability to cover the capital of your investment and make regular payments toward your property mortgage.
Lenders will also request to pull your credit score, and will typically only approve loans to applicants with a score of 680 or higher (though this exact number varies lender to lender), since they prefer to have the security of knowing that you can be trusted to make on-time payments.
If you think that any of the above requirements might prevent you from getting approved for a DSCR loan, you should consider applying with a partner who makes up for what you lack under the title of an LLC, that way you can strengthen each other financially and increase the likelihood of your loan request getting approved.
How Your Property Qualifies For a DSCR Loan
The majority of the requirements for DSCR approval are placed on the property itself, which is why it’s so important for you to select the right property to invest in. DSCR loans are intended to be used for commercial properties (properties that will generate income through rent), and are most commonly used for single family residential properties (of 1-4 units), multifamily rental properties, commercial properties (such as business parks), and short term or vacation rentals.
What is not approved for DSCR loans varies from lender to lender, but typically they do not cover; dome homes or log cabins, rural properties, manufactured housing, and mobile homes or other homes with a square footage of less than 750 feet. Most lenders also prefer to provide loans for rent-ready properties, meaning properties without any required maintenance.
The value of your property in its capacity to generate income is ultimately what determines the amount that lenders will be willing to give you for a maximum loan. This is why it’s so important, before you even begin looking at loan options, to do the proper research of the rental market that you are trying to invest in.
The most important thing to potential tenants, besides the property itself, will be the location. The location of your property will greatly influence the type of tenants that you attract. If you are hoping to rent to families, you will need to find a property in a highly rated school district. You should also extend your research beyond the property itself and consider looking into the rest of the neighborhood.
What are the comps for the area? What is the median income or employment rate for the neighborhood? How safe is it considered? All of these will be factors in deciding whether or not you can generate the income to pay off your investment property mortgage.