Unleash Your Real Estate Potential with DSCR
Real estate is one of the safest investment markets. Through bears and bulls, you can still rely on the passive income from your rentals. The only time in recent history that real estate investment took a hit was during the height of the pandemic, and even then, the US released aid for small businesses. As any veteran investor can tell you, one of the more difficult aspects of real estate is figuring out your taxes and financing properties.
Traditional loans can get difficult to apply for, especially as you expand your portfolio with new properties. Banks and conventional lenders have strict underwriting guidelines to adhere to that rely strongly on your personal income verification.
Or, you can invest using your properties’ debt-service coverage ratio (DSCR).
Your DSCR looks at the Net Operating Income and the overall expenses of your property. It then plugs these amounts into a quick formula— your NOI divided by your expenses. DSCR shows how well your current properties are performing; it can also estimate how well a potential property will perform. A DSCR of 1.0 means you are covering your debts but not pulling a profit. Under means you are losing money, and over means you are making money.
Increasing your DSCR involves increasing the value of your property. You can either raise your income or lessen your expenses. You want to aim for a DSCR of at least 1.25 to make the metric work for you.
What are Debt Services?
The main amounts that count towards your DS can be remembered through the acronym PITIA: Principles, Interest, Taxes, Insurance, and Association Dues. These are major expenses with any property, but you can count other things as well. If you hire a property management company, pay utilities, or pay for a service like landscaping for the property, these count towards your overall expenses to maintain the rental property.
How DSCR Can Help You Finance Properties
By obtaining a minimum DSCR of 1.25, you start to qualify for DSCR loans. So, what is a DSCR loan?
DSCR loans are non-traditional financing options offered by private lenders, credit unions, and banks that are geared specifically to investment properties.
Lenders use DSCR to calculate the risk of lending to you. DSCR loans have less strict guidelines than traditional loans, and they offer longer repayment periods. They also have a higher LTV, so you can generally expect a 20-25% down payment. If you’re asking what’s the catch: you will have a 1-2% higher interest rate. That’s It.
DSCR Loan Requirements
Requirements always vary by lender, so you’ll need to do due diligence when planning to apply. However, there you can generally expect the need for a 640 credit score and a 1.25 DSCR. Portfolio DSCR loans allow you to combine multiple DSCR loans under one payment, but they generally have higher requirements for DSCR and credit score.
One of the benefits of DSCR loan requirements is they are based on the property potential or your other properties’ performance rather than your personal income. Gathering necessary documentation is a simpler process, as you generally get the property appraisal from the listing paperwork and go from there.
What Can You Finance with DSCR Loans?
A DSCR loan is specifically for rental properties, so you cannot use it for your primary residence. However, it covers a wide variety of property types. You can use DSCR for short and long-term rentals. Vacation rentals, apartment complexes with five or more units, single-family residences, office buildings, and more fall under the umbrella of coverage.
You can also use DSCR Loans to refinance properties. One popular use is to refinance hard money loans that were used to originally finance the property after the property has had time to build DSCR.
Building Your Real Estate Portfolio
Some investors stick with a single property type, while others like to diversify. It’s up to you what type of properties you want to invest in, but it’s a good idea to have a plan for multiple properties before you start reinvesting profit. Some business relationships to consider are real estate agents, real estate attorneys, and property management services.
Real estate agents can handle the nitty gritty of purchasing and negotiations. If you have long-term rentals, they can also help you find tenants. This means you won’t have to worry about interviewing tenants or performing a background check.
A real estate attorney is a great idea when getting started and when branching into new states. They can help ensure your properties are up to code for renting and handle your lease agreements. If you run into an issue with a tenant, you can turn the matter over to your lawyer.
Some investors love being landlords and take a hands-on approach to property management. This works until you have more properties than you can handle. Property management companies can help you balance the load again or take over entirely.
Real estate investing can be a lucrative pursuit, whether you go for one property or a dozen. Just make sure you’ve done your due diligence on property management and state laws for the property’s location. Then, sit back and enjoy the extra income.
This article has been published in accordance with Socialnomics’ disclosure policy.