Investors looking to expand their portfolio may consider obtaining a DSCR loan. A DSCR loan is a type of unsecured loan that allows borrowers to borrow money from a bank or lender against an asset like an investment property.
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What is a DSCR loan?
A DSCR loan is a specific type of asset-based financing. It stands for debt service coverage ratio and is used to determine the profitability of a property. It is calculated by dividing the monthly mortgage payments by the net operating income (NOI), which is the total income a property produces minus operating expenses like maintenance and taxes. This number is used to assess a loan’s health and calculate the maximum loan amount that a lender can issue to a borrower based on certain requirements.
For instance, lenders will generally require a DSCR of 1.25 or higher for a property to be eligible for an investment property loan. However, a DSCR of 1 or lower may indicate that the property is underperforming and that it is not generating enough income to cover its expenses. In this scenario, a lender may not be willing to extend you a large enough loan to finance the purchase.
How is DSCR calculated?
Key components of debt service coverage ratio loans in Arizona are net operating income, monthly payments, and the loan-to-value ratio. The net operating income is calculated by taking the property’s monthly or annual rental income and subtracting the monthly or annual operating expenses such as taxes and insurance. For example, a score of 1 would mean that the monthly costs are equal to the rental income.
The higher the score, the more profit is being made from the property, which makes it more attractive to lenders. There are a few ways to raise the score, including paying a larger down payment to reduce the loan-to-value ratio, increasing the rent, or reducing the operating costs on the property.
Once the net operating income has been determined, the next step is calculating the monthly mortgage payment by multiplying the principal loan amount by the interest rate and adding property taxes and insurance premiums to the equation. Finally, the loan-to-value ratio is calculated using the principal loan amount divided by the value of the property. This is often referred to as the LTV or LTV ratio.
For example, an LTV ratio of 70% means that the borrower has borrowed $70,000 on a property valued at $100,000. This shows how much of the property’s value is being financed with debt and how much equity is being retained by the owner. Generally, the higher the LTV ratio, the riskier the loan will be for the lender because the property is more expensive to pay off in the event of a default. Ideally, you should aim to keep this ratio below 80% unless you can afford to pay the extra interest payments over time.
What to Look For In A Lender
Borrowers should research a lender online by reading customer reviews and testimonials to ensure that the company offers honest and reliable services. A borrower should also look for an established lender that has been in business for at least five years and has a proven track record of satisfied customers.
A good lender should offer low-interest rates and flexible repayment terms to help borrowers meet their financial goals. An established lender will have high ethical standards and will not engage in deceptive or misleading business practices.
Finally, borrowers should ensure that the loan officer is friendly and knowledgeable about the products and services offered. Determining the amount of a down payment will have an impact on your DSCR. The greater your down payment, the lower your loan-to-value ratio will be, improving your credit score and lowering your mortgage rate.
Lenders use your credit history and income to determine your eligibility for a loan and the amount you can borrow. However, in Arizona, Cash flow is more important than income and credit score. Income can be verified by providing pay stubs. In contrast, cash flow is typically calculated by taking the gross amount of net income and subtracting expenses in order to come up with available funds that can be allocated to the repayment of a debt.
A DSCR of 1.5 or higher is generally considered to be an acceptable figure. With a higher DSCR, you can expect to pay a lower interest rate on the loan and achieve better long-term financial outcomes by avoiding debt traps.