Rental property owners understand the grind of trying to grow and expand investments. One of your biggest challenges is to secure financing for said growth. That’s where debt service coverage ratio loans, or DSCR loans, come into play. DSCR loans can help you maximize your rental business potential by providing the funding you need to take your real estate portfolio to the next level.
What is a DSCR Loan?
A DSCR loan is a real estate investment loan that takes into consideration your current managed rental properties’ cash flows to determine your eligibility for financing. Lenders use a formula to calculate your debt service coverage ratio, which measures your business’s ability to cover debt obligations. The higher your DSCR, the better your chances of securing the loan.
How You Can Calculate Your Debt Service Coverage Ratio
Calculating a debt service coverage ratio is a relatively simple process that involves dividing your rental’s Net Operating Income (NOI) by its Total Debt Service (TDS).
- DSCR = Net Operating Income/Total Debt Service
To calculate your NOI, start with your gross revenue and then subtract your operating expenses. These expenses include things like utilities and salaries—any cost associated with running your rentals. For the TDS, add in all of your business debt obligations. This includes things like principal and interest payments on loans, leases, and other financing arrangements.
Once you have your NOI and TDS, you can plug those numbers into the formula to calculate your DSCR.
For example, if your rental has an NOI of $200,000 and a TDS of $150,000, your DSCR would be:
- DSCR=$200,000/$150,000
- DSCR=1.33
The example DSCR would be 1.33, showing that your property generates an income substantial enough to cover its debt obligations 1.33 times over. Generally, lenders prefer to see a DSCR of at least 1.25; however, the specific requirements often vary depending on the lender and the type of financing you seek.
It’s worth noting that the formula for calculating the DSCR can be modified slightly depending on the lender’s specific requirements. For example, some lenders may include additional factors, such as depreciation or amortization, in their calculations. It’s essential to understand the particular requirements of your preferred lender before calculating your DSCR to ensure that you’re using the correct formula.
How to Qualify for a DSCR Loan
Strong Cash Flow
First comes the DSCR itself, which should be a minimum of 1.25. Some lenders may require higher. Your property’s rental revenue must also meet or surpass the lender’s requirements for a coverage ratio. This is calculated as monthly rental income divided by mortgage payment. This is generally somewhere between 1.0 and 1.5x.
FICO
Most DSCR lenders are looking for a score of 680+. The higher the Loan-To-Value ratio, the higher the score needs to be. A lender providing a Loan-to-Value ratio of 80% may require a credit score of 700 instead.
Lender Variances
Do remember that your chosen lender will have their own specific guidelines, as well. The above values are generic starting points, but you should look into reputable lenders to determine what else you may need.
How Can A DSCR Loan Maximize Your Business Potential?
Fund Growth Opportunities
Whether you’re looking to open new locations, invest in blockchain technology, upgrade facilities, or hire additional staff, a DSCR loan can provide the funding you need. With a higher DSCR, you’ll be more likely to qualify for the financing you need to fund your growth opportunities.
Improve Cash Flow
A DSCR loan can also help you improve your cash flow. By consolidating high-interest debt or refinancing existing loans, you can reduce your monthly obligations and free up cash to reinvest in more real estate opportunities.
Build Credit
As you make on-time payments on your DSCR loan, you’ll be building up your business credit. This can help you qualify for better financing terms in the future and position your rental business for long-term success.
The Bottom Line
By taking into account your managed rental properties’ cash flows and your debt obligations, DSCR loans provide a flexible financing plan that can help you fund your investments and grow your portfolio. If you want to learn more about DSCR loans and how they can benefit your real estate investments, reach out to a reputable lender today. They can help you understand the requirements and regulations, as well as guide you through available options for your DSCR. By working closely with your lender, you can maximize your potential with a DSCR loan.
