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    Real estate investors seeking an investment property loan should consider their debt service coverage ratio (DSCR) to measure their cash flow and ability to pay debts. Lenders can use a borrower’s DSCR to determine their ability to repay the loan based on cash flow rather than income or job history. 

    DSCR loans, also known as no-income mortgage loans, allow borrowers to invest in real estate while avoiding high rates, lengthy approval processes, and strict lending criteria to qualify based on cash flow rather than personal income. 

    If you’re a real estate investor, you may take itemized deductions on your taxes that reduce your taxable income and affect your ability to obtain a mortgage loan. While conventional loans consider your income, DSCR loans make it easy to qualify based on your rental income to help you start earning more quickly without needing to prove your ability to repay with bank statements. 

    DSCR Meaning: What is DSCR?

    Debt service coverage ratio (DSCR) refers to the amount of net cash flow a borrower has available to pay their mortgage. It’s a metric used by investors and lenders to analyze the performance of rental properties and determine whether borrowers qualify for a loan. DSCR compares a borrower’s rental income against the annual debt of the mortgage loan. 

    Calculating DSCR will give you a ratio that indicates whether a property generates enough income to pay a mortgage. Lenders typically use this measurement to determine the maximum loan amounts when investors apply for mortgages.

    Alt: Three people sitting at a desk looking at documents and using a calculator.

    Generala, the higher a DSCR, the more cash flow there is to cover the debt and provide the borrower with a cushion to pay for additional property expenses while taking some as income. To use the DSCR formula to determine your ability to repay a mortgage loan, divide the annual gross rental income by the total annual debt payments. 

    Once you have that figure, you can determine whether or not you qualify for a loan based on a lender’s eligibility requirements. A DSCR of 1 shows that you have a gross rental income equal to the annual payments of your mortgage debt, proving your ability to repay. 

    DSCR loans are often easier to qualify for and have faster times to close than traditional investment property loans. Additionally, with no income verification, a borrower’s eligibility only depends on a single figure—-their debt service coverage ratio. 

    These loans offer many benefits for investors, including the following:

    • Large loan amounts up to $5,00,000
    • 20% down payments
    • Minimum credit score required
    • No limit on the number of properties
    • Interest-only loan options are available
    • All types of rental properties are eligible, including short and long-term rentals

    What Is a Good DSCR?

    As we’ve mentioned, a DSCR ratio of 1 means that you have precisely enough rental income to afford to repay the loan. But what is a good debt service coverage ratio in real estate? Ultimately, a DSCR above 1 is better than a ratio at or below 1 because it indicates a stronger position and ability to repay debts. 

    A debt service coverage ratio above 1 means a property is generating income, which is good for both the borrower and lender. 

    The minimum DSCR requirements vary by lender and depend on several conditions, including the economy. If credit is more readily available, lenders may accept lower ratios. However, most lenders look for a DSCR of at least 1, but ratio requirements of 1.25 to 1.5 are the most common. 

    Borrowers with a DSCR lower than 1 may still qualify for an investment property loan. However, since a lower DSCR can only cover part of the annual debt payments, borrowers will need to use personal accounts to pay off their monthly mortgage loans. Lenders don’t like to see negative cash flow, but some may allow it if you can prove your ability to repay in other ways, such as through income verification in the form of bank statements. 

    Even a DSCR higher than 1 can be problematic for some lenders. For example, a DSCR slightly higher than 1 at 1.2 may demonstrate that a change in cash flow could make the borrower unable to repay the loan. 

    Additionally, some lenders may require borrowers to maintain a minimum DSCR during the life of the loan, and some agreements will consider the borrower to be in default if they maintain a consistently low DSCR. 

    How DSCR Affects Loan Terms

    DSCR not only affects a borrower’s ability to obtain a loan, but it can affect the loan terms, including how much a borrower qualifies for. 

    For example, when a property has a DSCR below the lender’s minimum, the lender may reduce the loan amount until the borrower raises their DSCR to the minimum. Additionally, lenders can demand collateral or refuse to extend the loan if a DSCR falls below their minimum requirement. 

    What Loans Can I Get With a Low DSCR?

    Griffin Funding is a premier provider of DSCR loans nationwide, and our requirements are more flexible than many other lenders. Instead of requiring a 1.25 DSCR, we offer these loans for borrowers with a DSCR as low as .75. However, if you fall below our requirements, we still have other non-QM mortgages available you might qualify for, including some of the following:

    • Interest-only loans: These loans allow investors to save on monthly mortgage payments for the first portion of the loan. Your payments will only apply to interest instead of the principal amount during this time. 
    • Bank statement loans: With bank statement loans, we’ll determine your ability to repay by using your bank statements to verify personal income instead of tax returns. This option is ideal for borrowers who take the itemized deduction when doing their taxes and have significant expenses.  
    • Recent credit event loans: If you have bad credit due to a recent credit event, you may still be eligible for a recent credit event loan to help you start investing in real estate. 

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    How to Improve Your DSCR

    All DSCR loan lenders require a minimum DSCR. However, the exact ratio value required varies by lender. For example, while Griffin Funding requires a minimum DSCR of 0.75, most lenders typically look for 1.25 to 1.5. 

    In either case, if your DSCR is too low, you may not qualify for a loan. Additionally, even if you qualify for a loan, your maximum loan amount may still be too low to purchase your investment property. Increasing your DSCR is the best way to get lower interest rates and improve your chances of getting approved for a loan. 

    Here are a few ways borrowers can improve their DSCR before applying: 

    Interest Only Loan

    One of the best ways to increase your DSCR is to apply for an interest-only loan. Reducing your debt payments on your investment property means having a higher DSCR in the lender’s eye.

    Increase Rental Income

    You can increase your rental income by raising or filling vacancies faster if you can’t cut costs. While rents usually increase slightly every year, you should only increase rent substantially if you have renovated or improved the unit. Meanwhile, filling vacancies can help you earn more money to increase your income, but it can cost money in marketing. Adding amenities can also go a long way.

    Refinance

    Refinancing your existing mortgage loan can help you save money in the long run by reducing your monthly payments with more favorable interest rates and terms. A lower interest rate means you’ll pay less over the life of the loan, effectively reducing your monthly payments. 

    Raise Property Value

    Raising the property value is another option, but it may require a substantial loan. While property values typically increase yearly, you can invest in renovations that allow you to increase the rent and attract more tenants, which will increase your cash flow. 

    Alt: Tiny houses on top of stacks of coins of various heights, with a hand holding an arrow pointing upwards above them.

    Negative Cash Flow DSCR Loans

    Negative cash flow DSCR loans, also known as no ratio DSCR loans, are riskier and, therefore, come with stricter underwriting standards and higher down payments.

    • Minimum loan amount: $150,000 ($3,000,000 maximum)
    • Minimum down payment: 25% up to $1,000,000 (add 5% for Short Term Rentals)
    • Minimum down payment: 40% up to $3,000,000 (add 5% for Short Term Rentals)
    • Minimum credit score: 700 FICO

    What are the reasons that you should consider acquiring a negative cash flow property using a no ratio DSCR loan?

    • There is an appraisal gap on the comparable rents. There are not enough rental comps to accurately show the true rental income issued by the appraiser and you are confident that the actual rent is higher.
    • You intend to carry out renovations to the property once it is acquired. These improvements will not only enhance the value of the property but also allow you to increase the rents. Consequently, this will result in a cash flow positive position for you.
    • You are currently renting out your investment property below market with a lot of tappable equity and want to do a cash-out refinance to rehab the property to increase rents and/or acquire another property that will help offset the negative cash flow.
    • You are purchasing a property that utilizes ADU income on an unpermitted ADU (which the lender can’t use for rental income qualification).
    • You are purchasing a property intending to build an ADU or multiple ADUs on it that will create positive cash flow.

    In the current market particularly, the allure to engage in an equity play is high, speculating on a 20-30% price increase should interest rates fall, with the aim of achieving quick financial gains. Many investors are willing to endure short-term losses on rents, banking on substantial appreciation in the coming years. However, most experts assert that, while investing in real estate, it is crucial not to lose focus on the fundamentals. They maintain that any appreciation should be regarded as a bonus, not a given certainty.

    Another more precarious rationale involves situations where the property does not generate positive cash flow at the prevailing Debt Service Coverage Ratio (DSCR) interest rates; however, it could potentially do so if interest rates decline in the future, coupled with the average annual rent growth. The strategy here is to acquire the property now and opt for rate/term refinancing later, or sell if values escalate sufficiently. Relying on a decrease in interest rates is generally not advisable as interest rates are, to a large extent, beyond one’s control. Investment properties should either be generating cash flow presently or have a robust plan in place to ensure positive cash flow in the future.

    Avoid purchasing a property with negative cash flow if you lack a strategic plan to enhance rents. The team at Griffin Funding can review historical appreciation in your market; if it reveals an area with sluggish growth and minimal pent-up buying demand, you might not realize quick profits even when the market shifts. If the property doesn’t generate positive cash flow with your loan calculated at the prevailing DSCR rates, and there is no avenue to raise rents, it may not yield positive cash flow for a prolonged period, potentially becoming a financial drain. Overpaying or investing in unfruitful ventures is something everyone wants to steer clear off.

    Apply For a DSCR Loan

    DSCR loans are excellent options for new and veteran real estate investors who don’t qualify for another loan based on their income. Instead of using tax returns, pay stubs, or bank statements to verify income, lenders will calculate a borrower’s DSCR to determine their ability to repay the loan and the loan amount a borrower qualifies for. 

    If you’re ready to invest in real estate, apply for a DSCR loan with Griffin Funding. Our mortgage experts can help you through the entire process, from application to closing, for a streamlined experience. Apply with Griffin Funding today. 

    Bill Lyons

    Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.