What is Debt Service Coverage Ratio (DSCR) Program
Understanding why property investors love this new program
By Kevin Nichols, Published: 3/25/22
What is it?
A loan program that is becoming increasingly popular lately for Investment properties is the Debt Service Coverage Ratio (DSCR) Program. The DSCR program can only be used to finance investment properties but Single Family Homes, Multi-Family Homes up to 4-units, Condos, and PUD’s are all eligible for this program.
Simply put, the financing guidelines are based completely off of the income the property will generate, and have nothing to do with the Borrower’s personal debts or income.
The ratio is described as:
Net operating income
DSCR = ——————————————
Total Debt Service
The Net Operating Income is just the monthly rent minus any operating expenses (such as utility bills).
Total Debt Service is the total housing expense for the property, so that’s the mortgage payment plus property taxes, homeowners insurance and HOA dues (if applicable).
Simple right? Don’t worry: all you need to know is that the rent received for the property will be our income, and the monthly payment will be the number that the rent needs to cover.
Why is this loan program becoming so popular?
ABSOLUTELY NO PERSONAL INCOME DOCUMENTATION REQUIRED!
No W2’s, no Tax Returns, no pay stubs. Because of this, the underwriting process on the DSCR program can be much more straightforward since only the details of the property itself are considered. That means a quicker close so that you, the Borrower, can have that property generating cash flow in less time than a Conventional Underwriting process.
Real estate investors are using this program to build their real estate portfolio without the headache of strict Fannie Mae and Freddie Mac underwriting guidelines you find with conventional loans. This makes sense, because the purpose of Fannie Mae and Freddie Mac is to facilitate home financing for the average homebuyer not the average investor, hence the stricter guidelines and loan limits.
So, what IS required then?
For a DSCR qualification, we need three items:
- A down payment (minimum 15% down)
- A credit score (minimum 640)
- An income-approach appraisal (see next section)
With such limited documentation, we see these close in as little as 2 weeks once a property is selected.
What is an income-approach Appraisal?
For a purchase, the income-approach appraisal will estimate the gross rental income based on comparable rental properties in the area to make an estimate of what your property should generate when you begin renting it. If you’re refinancing, they will use your existing rents along with an assessment of the local market to ensure that it is reasonable. That rental number, minus certain operating expenses, to determine the net operating income of the property and that’s our income for loan qualification.
So, what does the ratio need to be to qualify?
It depends, but simply we can go as low as .75 DSCR (meaning the rent covers just 75% of the total monthly payment), however the higher the ratio, the better the interest rate will be.
Good: >=0.75 (The net operating income covers 75% of the property’s debt)
Better: >=1.00 (The net operating income covers 100% of the property’s debt)
Best: >=1.25 (The net operating income covers 125% of the property’s debt)
So, pricing is adjusted based on the interest rate at each of these different ratio “tiers” with 0.75 being the minimum. There will also be stricter credit and down payment/loan-to-value requirements at a lower DSCR. For example, if the ratio is below 1.00, you may need to put down 20% instead of 15%, or you may need to be at a 680 FICO etc. As an investor, the higher the ratio the better of course so that the property pays for itself, and the lender who is offering you the money looks at this the same way.
A few notes…
- There is never mortgage insurance on this program
- First-time homebuyers are not eligible (you must have bought real estate in the past)
- Down-payment funds must be sourced (personal assets are preferred without a CPA letter)
- Cashout refinances are allowed
- Reserve requirements vary, but generally are 6-12 months worth of property’s debt
- Accepting a prepayment penalty will improve the rate. Options of 0-5 years.
Ultimately, the DSCR programs offered by Cali’s Best Lenders are some of the most powerful tools available for acquiring real estate, especially as your portfolio grows beyond Fannie Mae limits. I’d love to help you qualify with this or one of our other great programs, so get in touch and thanks for reading.
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