DSCR loan: How to use rental income to get a mortgage

Getting a conventional mortgage can seem quite daunting and complicated, often requiring scores of documentation by lenders. Depending on one’s financial situation, the paperwork that is often needed to get approved for a conventional mortgage can include tax returns, pay stubs, proof of income, bank statements, credit history, credit scores, employment history, tax returns — the list goes on and on.

In some situations, collecting and presenting all this documentation to a lender can be quite arduous, taking weeks or even months, causing significant delays in the mortgage application process, and ultimately, causing delays in purchasing the property. In other situations, this difficult process creates a barrier for potential borrowers — many people, such as foreign nationals, might not have all the necessary documentation required, making them ineligible for a conventional mortgage.

In these instances, when the required documentation is either unavailable or non-existent for a potential borrower, many people turn to hard-money lenders. However, before considering any hard-money lender options, it’s important to know that there are other types of loan products available besides conventional mortgages that could fill very similar needs. One of these alternative mortgage options is a debt-service coverage ratio loan (DSCR loan), and it requires just a fraction of the documentation that is needed for a conventional mortgage.

What is a DSCR Loan?

A DSCR loan, or a cash-flow loan, is a type of loan whose terms are dependent upon the value of the property that is being purchased rather than by the value of the borrower’s current assets and credit history. With this type of loan, a lender assesses the value of the property being purchased, determines how much rental income the property might be able to generate — also known as the property’s cash flow or net operating income (NOI) — and then sets the terms of the loan.

For many people, such as real estate investors who might not have any actualized annual income or foreign nationals who might not have a credit or FICO score, getting a conventional loan might be difficult, causing them to look at hard-money lender options.

However, for those that are eligible for a DSCR loan, they should consider it as a viable option, as its terms usually fall somewhere between a conventional mortgage and a hard-money loan.

How Does a DSCR Loan work?

The process for getting a DSCR loan is slightly different from that of getting a conventional loan, as different documentation is required. Due to these differences, lenders utilize different metrics to determine if a borrower will have the ability to pay back the loan.

Whereas for a conventional mortgage the key metric used to determine monthly payments is a person’s debt-to-income ratio, for a DSCR loan the key metric used is a person’s debt-service coverage ratio.

To determine the amount of money, the interest rate, and the duration of the loan, lenders take into consideration two main factors to formulate a person’s debt-service ratio:

1. Net Operating Income
2. Total debt service

In this instance, the net operating income refers to how much money a property can generate — so, for a rental property, it’s the amount of rental income. The total debt service refers to the total costs of the property. These costs might include, but are not limited to, monthly mortgage payments, property taxes, homeowners insurance, and homeowners association fees.

In regards to the debt coverage service ratio, a 1:1 ratio means that the cash flow generated by a property is equal to the costs of the property. If the ratio is above 1, it means that the property has a positive cash flow, and vice versa. Every lender has different terms on which they offer a DSCR loan, but some lenders might offer a loan at a ratio as low as .6 or .7.

However, due to the fact that DSCR loans often require less documentation than conventional loans, higher down payments are usually required — LTV’s for DSCR loans are usually around 65-75% — and higher interest rates are charged.

What is Required for a DSCR loan?

As we mentioned, DSCR loans don’t have the same requirements as conventional mortgages. Also, unlike conventional mortgages, DSCR mortgages are not backed by entities like Fannie Mae and Freddie Mac, so there are no standardized requirements across the DSCR loan industry. For this reason, requirements for DSCR loans vary across lenders.

Here at Milo, we can only speak to the documentation and guidelines that are required to get a loan with us.

To be eligible for a DSCR loan, there are only a few documents needed. First and foremost, a valid passport is required. If you are a foreign national, a valid passport and a U.S. Visa is required. Additionally, payment for the property appraisal will be necessary, as well. This money will need to be set aside early in the process, as the property appraisal is one of the first steps in ensuring a loan, as it verifies the fair market value of the potential property and also determines how much rental income the property should be able to generate.

Next, verifiable income is required. Either two months of bank or brokerage statements are required to verify and assess your monthly income. In addition to verifiable income, two separate reference letters from either credit institutions or banks are necessary, as well. Last, but not least, a valid U.S. bank account is required too.

What are the advantages of a DSCR loan?

For those that might not be eligible for a conventional mortgage, a DSCR loan might be the next very best option. Though you might have a slightly higher interest rate and have to pay a larger down payment, it’s important to understand all the advantages of a DSCR:

• Less documentation needed when compared to a conventional loan

• Focuses more on the property than on the individual, so you can borrow against the rental income the property might be able to make rather than borrow against your credit history and assets

• Due to the fact that there is less documentation needed, DSCR mortgages generally close quicker than conventional mortgages

For those that are looking to buy a property, but might have the proper documentation that is required for a conventional loan, a DSCR loan might make sense. However, there are many more aspects to keep in mind when examining if a DSCR loan is the right financial move, and a lot of these are situationally dependent. We advise you to speak with your financial consultants to see if a DSCR option might be the right move for you.

To learn more, speak with our loan consultants today.

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.