Your Guide to Investing With DSCR Loans
The real estate market provides opportunities for wildly lucrative investments. You might have thought that tapping into the market was only possible for investors with deep pockets. It turns out that with the right loan, investing in rental properties is a possibility for almost anyone. Here’s how you can do it, too.
DSCR Loans
Debt service coverage ratio (DSCR) loans are a great tool for newer investors. Typically, approval for mortgage loans is dependent on the financial situation of the buyer. Lenders won’t usually give out loans unless buyers can prove that they have the income available to be able to afford the monthly loan payments they’ll be taking on. The reason why DSCR loans are so great for new investors is because of how different the approval process is. With these loans, instead of granting them based on your income, lenders will use a specific formula to determine the potential value and return on the property that you’re investing in.
This formula usually takes your net operating income—how much rental income you get after taking out all of your expenses—divided by your annual debt. The result that you get is your debt service coverage ratio. Lenders will use the DSCR formula and calculation to approximate your potential earnings and determine whether or not you’ll be able to make the required payments. Ideally, most lenders will want you to have a debt service coverage ratio of 1.2 or higher before giving you a loan. So, you must do your research and pick the right property to guarantee that you get approved.
Rental Type
Something that lenders value when it comes to granting DSCR loans is predictability. Because of this, you’re much less likely to get approval if you intend to use a property as an Airbnb or another type of vacation rental. To increase your chances of getting approved, you should try to focus your property hunt on single-family homes. These will be the easiest properties to keep occupied and will therefore ensure a steady rental income.
Condition
The condition of your rental property is going to sway lenders. Ideally, you should look for rental properties that are practically move-in ready. If your property needs repairs, it should be incredibly small and easy to take care of. Big projects are a deterrent for lenders because they waste too much time and money. Big repairs could cause your timeline to be pushed back drastically while you wait for them to be finished, costing you a month’s worth of revenue, maybe more. For this reason, you should look for recently renovated properties. Not only will these save you time and money on repairs, but they’ll also be more attractive to potential renters.
Location
The location of your rental property is going to be one of the most important factors in guaranteeing your loan approval since the location will greatly influence your popularity with renters. Believe it or not, oftentimes renters will place more value on the location of a property than the condition of it. Potential tenants care most about finding a property that fits their needs. You can use this to your advantage and shape the demographic of your renters by choosing specific locations. For example, if you were to invest in a property that was within walking distance to both the local college and the downtown area with bars and restaurants, then most of your applicants would likely be college students looking for off-campus housing.
Alternatively, if you purchased a rental property in a quiet suburb, close to the town schools, then your property would likely be more appealing to families. To increase your chances of having a steady rental income, you should try to purchase a rental property that is central to commonly desired amenities like grocery stores, gyms, and public transit. Additionally, when deciding on a location, you should compare the data of potential neighborhoods. Pay attention to the things that will most impact the value of your rental property, like crime rates, average income, and average property value. All of this information will help you decide on the best property to invest in.
Safety Net
While your financial situation is not the main factor that lenders will focus on when deciding whether or not to give you a DSCR loan, it is something that could potentially help. If your debt service coverage ratio is good, but not great, then lenders will feel much more comfortable giving a loan to someone with existing capital. This tells them that you’ll be able to continue making the required payments on the loan even if the property itself is struggling.