What Is a Debt Service Coverage Ratio?
The debt service coverage ratio (DSCR) is a financial metric that compares the property’s annual gross rental income and its annual mortgage debt, including principal, interest, taxes, and insurance. When investing in real estate, this metric can help lenders measure a borrower’s ability to produce enough cash to cover their debt obligation, including interest, principal, taxes, insurance, HOA (if applicable), and second mortgage/HELOAN payment (if applicable).
To calculate the DSCR, you take the property’s gross rental income and divide it by the total debt service. What you’re left with is a decimal. A DSCR of 1 means your rental property generates enough cash to cover its debt, while a ratio greater than 1 indicates borrowers have a buffer. Conversely, a DSCR of less than 1 is considered negative cash flow and suggests the rental property doesn’t have sufficient income to cover its debt, which signals a potential risk for lenders. Before applying, we suggest using our DSCR calculator to determine your DSCR to see if you might qualify for the loan.
A property’s DSCR isn’t just a lending tool; it can provide investors with insights about their properties. For instance, if the property has a high DSCR, it indicates the property generates a significant amount of income relative to its existing mortgage. Meanwhile, a declining DSCR might suggest decreasing rental incomes, rising expenses, or both.
In terms of loans, the DSCR is designed to provide lenders with a clear perspective on the financial health and risk associated with a borrower by focusing on the rental income’s ability to repay the debt.
How Do DSCR HELOANs Work?
At its core, a DSCR home equity loan evaluates the borrowing potential based on the property’s income-generating capability. Lenders calculate the DSCR to determine the risk level and likelihood the borrower will repay their loan.
The key advantage of this approach is its flexibility for real estate investors. Those who have diverse income streams or more complex financial scenarios might find it challenging to secure traditional loans based on standard criteria. However, with DSCR HELOANs, investors can tap into their investment property’s equity using the income it generates.
With this type of financing, most DSCR lenders like to see a DSCR ratio of around 1.25 or higher, indicating a healthy buffer for debt repayment. However, lenders like Griffin Funding accept DSCRs as low as 1 on the DSCR HELOAN program. Some additional requirements to note when considering a DSCR home equity loan are:
- Minimum loan amount: $100,000
- Maximum loan amount: $500,000
- Prepayment penalty: Choose from 2-year, 1-year, or none
- Term: 30-year fixed
- Maximum combined loan-to-value: 70% (meaning if your rental property is worth $1,000,000 and the existing first mortgage is at $500,000, the maximum DSCR HELOAN loan amount you’d be able to qualify for would be $200,000)
- Property types: Only investment properties are eligible for DSCR HELOANs and an appraisal with comparable rent schedule 1007 is required
Benefits of DSCR HELOANs
DSCR HELOANs are designed with the unique needs of property investors in mind to offer an adaptable and advantageous financial solution. Whether you’re looking to renovate or leverage property equity to buy more investment properties, these rental property loans can help you secure the funding you need. The benefits of DSCR HELOANs include:
- No tax returns necessary: Traditional loans require detailed tax returns to assess a borrower’s financial health. With DSCR HELOANS, the focus is on the property’s income rather than personal income.
- No traditional income verification: Rather than evaluating personal earnings, DSCR lenders look at the property’s rental income, making the qualification process much smoother for investors.
- Leverage equity and access cash: Just like traditional home equity loans, DSCR HELOANs allow borrowers to tap into the accumulated equity of their investment properties without having to touch the rate on their first mortgage.
- Streamlined approval process: By focusing on the property’s income and not the borrower’s financial situation, the approval process can be more straightforward and faster than traditional loans.
- Flexibility: DSCR HELOAN lenders may offer more flexibility in borrowing terms. For instance, a lender might provide a larger loan amount or more favorable terms if the DSCR indicates the borrower has significant income relative to their debt obligations.
Keep in mind there are pros and cons of DSCR loans and HELOANs investors should consider. For instance, DSCR loans typically require higher down payments and interest rates.
Contact us today to learn if a DSCR HELOAN is right for you. By talking to one of our mortgage experts about your unique financial situation, we can help you find the right home equity loan based on your needs.
DSCR HELOAN vs a DSCR Cash-Out Refinance
If you are considering accessing cash from your existing rental property you should compare the benefits and limitations of DSCR HELOANs and DSCR cash-out refinance loans.
- Maximum loan amount: $500,000 vs $5,000,000
- Maximum loan-to-value: 70% vs 80%
- Minimum DSCR: Greater than 1 vs less than 1
- Interest Rate: DSCR HELOAN interest rates are significantly higher than DSCR c/o refinance loan rates
- Payments: Two payments vs one
How to Get a DSCR HELOAN
Griffin Funding offers a straightforward and streamlined application process. To apply for a DSCR HELOAN, follow these steps:
- Complete an online application: Gather all necessary documentation, such as proof of rental income and existing debt documentation. Then, complete our online application.
- Appraisal: Once you’ve completed your application, we’ll order a third-party appraisal to determine the property’s market value and comparable rents.
- Underwriting: After you’ve sent us all the necessary documentation for your application, we’ll go through the underwriting process, where we calculate your DSCR based on proof of rental income, like leases and existing debt on the property.
- Loan approval: Once we obtain loan approval, we’ll reach out with anything else we need to finalize your loan documents.
Apply for a DSCR HELOAN Today
Leverage the full potential of your investment property with DSCR HELOANs. These loans recognize the value and income-generating power of your property. By focusing on rental income and the property’s value, DSCR HELOANs offer a tailored solution for investors, offering greater flexibility and opportunities to access capital.
Griffin Funding simplifies the application process to ensure you’re supported every step of the way. Our team of experts is dedicated to providing clear insights, competitive rates, and a seamless experience. Apply for a DSCR HELOAN online today to tap into your investment property’s equity.