DSCR Loan vs. Conventional Loan
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 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.
However, there are alternatives. Investors can qualify for a home loan without using their tax returns. You can avoid the high rates and points of private loans, lengthy approval processes, and strict lending criteria with a debt service coverage ratio loan (DSCR). Qualify based on your property’s cash flow, not your income. Securing a debt service coverage ratio loan can help you expand your investment portfolio easier than ever before.
Thanks to the folks over at Milo, we’ll explore this option below!
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:
Net Operating Income
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 who might not be eligible for a conventional mortgage, a DSCR loan might be the next 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 a Milo loan consultant today or visit milo.io
About Milo.io
Milo (milo.io) is a VC-backed technology-powered direct lender. They help people finance a place to live or invest with loan products that fit clients' needs. Milo originates loans in 38 states across the US. Leverage their online pre-qualification tool and print out your pre-qualification letter in five minutes or less.