What is Debt Service Coverage Ratio (DSCR) Program
Understanding why property investors love this new program
When you see rates posted online, the ad usually says “as low as” or has an asterisk next to it. Ever wonder why? The reason is that you almost definitely don’t qualify for that rate, and neither does anybody else! It’s click-bait. We’re here to give you an honest, accurate analysis of your unique scenario and find you the best possible rate that you DO qualify for, that won’t cost you a fortune at the closing table.
So what exactly is the “pricing” of an interest rate? It’s the cost to obtain an interest rate. Depending on the rate chosen sometimes there is no cost, and instead, a credit/rebate from the lender.
Below are six of the major factors that go into the pricing of an interest rate:
What is it?
A loan program that is becoming increasingly popular lately for Investment properties is the Debt Service Coverage Ratio (DSCR) Program. The DSCR program can only be used to finance investment properties but Single Family Homes, Multi-Family Homes up to 4-units, Condos, and PUD’s are all eligible for this program.
Simply put, the financing guidelines are based completely off of the income the property will generate, and have nothing to do with the Borrower’s personal debts or income.
The ratio is described as:
Net operating income
DSCR = ——————————————
Total Debt Service
The Net Operating Income is just the monthly rent minus any operating expenses (such as utility bills).
Total Debt Service is the total housing expense for the property, so that’s the mortgage payment plus property taxes, homeowners insurance and HOA dues (if applicable).
Simple right? Don’t worry: all you need to know is that the rent received for the property will be our income, and the monthly payment will be the number that the rent needs to cover.
Why is this loan program becoming so popular?
ABSOLUTELY NO PERSONAL INCOME DOCUMENTATION REQUIRED!
No W2’s, no Tax Returns, no pay stubs. Because of this, the underwriting process on the DSCR program can be much more straightforward since only the details of the property itself are considered. That means a quicker close so that you, the Borrower, can have that property generating cash flow in less time than a Conventional Underwriting process.
Real estate investors are using this program to build their real estate portfolio without the headache of strict Fannie Mae and Freddie Mac underwriting guidelines you find with conventional loans. This makes sense, because the purpose of Fannie Mae and Freddie Mac is to facilitate home financing for the average homebuyer not the average investor, hence the stricter guidelines and loan limits.
So, what IS required then?
For a DSCR qualification, we need three items:
A down payment (minimum 15% down)
A credit score (minimum 640)
An income-approach appraisal (see next section)
With such limited documentation, we see these close in as little as 2 weeks once a property is selected.
So, what does the ratio need to be to qualify?
It depends, but simply we can go as low as .75 DSCR (meaning the rent covers just 75% of the total monthly payment), however the higher the ratio, the better the interest rate will be.
Good: >=0.75 (The net operating income covers 75% of the property’s debt)
Better: >=1.00 (The net operating income covers 100% of the property’s debt)
Best: >=1.25 (The net operating income covers 125% of the property’s debt)
So, pricing is adjusted based on the interest rate at each of these different ratio “tiers” with 0.75 being the minimum. There will also be stricter credit and down payment/loan-to-value requirements at a lower DSCR. For example, if the ratio is below 1.00, you may need to put down 20% instead of 15%, or you may need to be at a 680 FICO etc. As an investor, the higher the ratio the better of course so that the property pays for itself, and the lender who is offering you the money looks at this the same way.
A few notes…
There is never mortgage insurance on this program
First-time homebuyers are not eligible (you must have bought real estate in the past)
Down-payment funds must be sourced (personal assets are preferred without a CPA letter)
Cashout refinances are allowed
Reserve requirements vary, but generally are 6-12 months worth of property’s debt
Accepting a prepayment penalty will improve the rate. Options of 0-5 years.
Ultimately, the DSCR programs offered by Mortgage 101 are some of the most powerful tools available for acquiring real estate, especially as your portfolio grows beyond Fannie Mae limits. I’d love to help you qualify with this or one of our other great programs, so get in touch and thanks for reading!
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