SS197: No Income Verification Mortgages (DSCR Loans)

SS197: No Income Verification Mortgages (DSCR Loans)

No-income verification Mortgages, also known as DSCR (Debt Service Coverage Ratio) Loans, do not require the borrower to provide proof of income. In this episode, Charles discusses DSCR loans, what they are, and how to be approved for one.

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Talking Points:

  • Before we start, I want to state that DSCR loans are not NINJA loans, which were a major cause of the Global Financial Crisis—referring to No-Income, No-Jobs, No-Asset loans.
  • What are DSCR Loans? DSCR Loans, also known as Debt Service Coverage Ratio loans, are a type of financing commonly used in commercial real estate lending where the loan underwriting is based on the income generated by the asset instead of the borrower’s personal income.
  • If you have ever applied for a mortgage on a 1–4-unit residential property, traditional lenders base their underwriting on the borrower, mainly the borrower’s income. If you have a good job and credit, they will easily lend to you and usually cap borrowers to 10 loans. The borrower’s income becomes less important once you buy 5+ unit multifamily and commercial properties. However, with DSCR loans, the borrower’s income is not a factor.
  • The Debt Service Coverage Ratio is an easily calculated financial measurement of a property’s ability to service its debt. You divide the Annual Net Operating Income by the Total Annual Debt Service amount. For example, if a property you want to purchase generates $100,000 per year in net operating income and the debt service obligation (principal and interest payments) is $80,000 yearly, the DSCR is 1.25x. The higher, the better. A DSCR of 1 means the property will break even, a DSCR over 1 means the property will generate cash flow for the owners after the debt is paid, and a DSCR under 1 means the property will lose money. Most lenders will want a DSCR of 1.2 or higher.
  • Before we break down the pros and cons of DSCR loans, it is important to note that all lenders want to see borrowers with liquid reserves left over after the purchase to ensure that they can maintain the property and avoid any problems without defaulting.
  • What are the Advantages of DSCR Loans?
    • Faster application process and easier to qualify for.
    • No personal income requirement or verification and minimal documentation are needed since a large portion of typical underwriting is based on verifying the borrower’s income and employment strength.
    • Available for multiple property types, from short-term vacation rentals to commercial and multifamily properties.
    • No property limit. Typically, there is no limit on the number of properties investors can finance with DSCR loans.
    • A straightforward loan qualification process typically reviewed and approved manually by human underwriters on a deal-by-deal basis.
  • What are the Disadvantages of DSCR Loans?
    • Down payments and loan-to-values. DSCR lenders usually require a down payment of 20%-30% of the property purchase price depending on property type, but this down payment amount can vary from lender to lender.
    • Minimum credit score. Many lenders will have a minimum credit score requirement.
    • Minimum DSCR: In research for this episode, I saw some lenders offering DSCR loans on properties with 1-2 units at a DSCR of 1, but most DSCR lenders will require 1.2, 1.25, or higher. In other words, you must find a property with real cash flow and/or put down a larger down payment.
    • Interest rates and fees. It is common for interest rates on DSCR loans to be higher than those on traditional mortgages. Lenders will usually charge higher loan origination fees than with other loan options.
    • Pre-payment penalties. DSCR loans might have pre-payment penalties, common with commercial mortgages but not with 1–4-unit residential loans.
    • Major value-add projects and vacant properties will be much harder to finance with DSCR loans since there is no solid cash flow to cover the mortgage. A hard money, bank loan, or bridge loan product might be better in this scenario.
  • How Do You Qualify for A DSCR Loan?
    • Investors can easily calculate if their property will qualify for a DSCR loan by calculating their DSCR and seeing if that meets the criteria set by their lender. Just make sure that your calculations include all of the property’s expenses, which, with smaller rental properties, are not usually accurately stated by the owner. About 8 or 10 years back, I spoke to a broker about an off-market property, like a 15 or 20-unit building. The seller didn’t include the property management expense in their numbers, and I inquired why this was, and the broker said it was because it was self-managed by the current owner. A DSCR lender, or any commercial lender, for that matter, would add this expense into the underwriting, which would lower the NOI and decrease the DSCR. A lower DSCR makes it harder to get approved for a loan.

A DSCR loan is a unique financing solution designed specifically for real estate investors, where the property’s cash flow is factored into the loan terms. It can be suitable for many rental property investors, especially those who might not have adequate personal income to qualify for a traditional mortgage. For investors with documented income, a traditional mortgage might be best for them since the loan terms are typically more favorable to the borrower.

Transcript:

Charles:
Being approved for a mortgage can sometimes be daunting, especially if you are a new investor or self-employed with minimal income. However, there are mortgage options that have become increasingly popular with real estate investors where the investor’s income is not verified, and in this episode, we will discuss their details. Welcome to Strategy Saturday; I’m Charles Carillo, and today we’re going to be discussing no income verification loans, also known as DSCR loans.

Charles:
So before we start, I wanna state that DSCR loans are not Ninja loans, which were a major cause of the global financial crisis, referring to no income, no jobs, no asset loans. So what are DSCR loans? DSCR loans, also known as debt service Coverage ratio loans are a type of financing commonly used in commercial real estate lending where the loan underwriter is based on the income generated by the asset instead of the borrower’s personal income.

Charles:
Now, if you ever applied for a mortgage on a one to four unit residential property, traditional lenders based their underwriting on the borrower, mainly the borrower’s income. If you have a good job and credit, they will easily lend to you and usually cap borrowers to 10 loans. The borrower’s income becomes less important once you buy five plus unit multifamily and commercial properties. However, with DSCR loans, the borrower’s income is not a factor at all. So the debt service coverage ratio is an easily calculated financial measurement of a property’s ability to service its debt. And you divide the annual net operating income by the total annual debt service amount. For example, if a property you wanna purchase generates $100,000 per year in net operating income and the debt service obligation, so the principle and interest payments is $80,000 a year. The DSCR is 1.25 x, so the higher the better.

Charles:
And A-D-S-C-R of one means that the property will break even A-D-S-C-R over one means the property will generate cash flow for the owners after the debt is paid. And the DSCR under one means the property will lose money. So most lenders will want A-D-S-C-R of 1.2 or higher. Some will want 1.25. It depends on the lender. Now, before we break down the pros and cons, that DSCR loans is important to note that all lenders wanna see borrowers with liquid reserves leftover after the purchase to ensure that they can maintain the property and avoid any problems without defaulting MM-Hmm, <affirmative>. Now, what are the advantages of DSCR loans? Well, faster application process and easier to qualify for. There’s no personal income requirement or verification, and minimal documentation are needed since a large portion of typical underwriting is based on verifying the borrower’s income and employment strength. It’s available for multiple property types from short term vacation rentals to commercial and multifamily properties.

Charles:
And there’s no property limit typically, there is no limit on the number of properties that investors can finance with DSCR loans, a straightforward loan qualification process, typically reviewed and approved manually by human underwriters on a deal by deal basis, which is much different than your traditional one to four unit kind of property financing when you’re going to a large bank. So what are the disadvantages of DSCR loans? Well down payments and loan to values. So DSCR lenders usually require a down payment of 20 to 30% of the property purchase price depending on the property type. But this down payment can vary from lender to lender. There’s usually a minimum credit score that lenders will have as a requirement a minimum DSCR. So in research for this episode, I saw some lenders offering DSCR loans on properties with one to two units at A-D-S-C-R of one.

Charles:
But most DSC lenders will require 1.2, 1.25 or higher. In other words, you must find a property with real cash flow and or put down a larger down payment interest rates and fees. Now it’s common for interest rates on DSCR loans to be higher than those of traditional mortgages and lenders will usually charge higher loan origination fees than with other loan options. And this goes around with all types of loan products that aren’t conventional, let’s say. So when you’re working with VA mortgages or FHA lower mortgages where you’re having lower down payments or no down payments, there’s gonna be very fee intensive. And so with here where you don’t really have to, the income on this side is not really satisfied that requirement. You’re gonna be paying higher fees and higher interest rates because of the ability of getting the loan with having one piece of the traditional mortgage application, not satisfied.

Charles:
So prepay and penalties. So DSCR loans might have prepay and penalties common with commercial mortgages, but not with one to four unit residential loans. So this is something that if you’re going in for a property you know, you gotta verify if you’ve if you’ve never used one of these loans before or any commercial loan before you just kind of understand exactly what the ramifications are. If you want to refinance it down the road, if you’re paying a lot of fees upfront for it or if it’s a pretty hefty pre PIM penalty, you have to understand and make sure that this, this loan product fits into your business plan and kind of your whole time for the property. Major value add projects and vacant properties will be much harder to finance with DSCR loans since there is no solid cash flow to cover the mortgage.

Charles:
A hard money or bank loan or bridge loan, a product might be better in the scenario for the investors because those products are, are really designed for going into a really heavy value add. Something that a property that needs a large renovation and they’re aware of how that works and that loan product is designed for that for that period of time. DSCR is really going into a property. And yes you can buy properties that are value added with DSCR loans. However, it’s one of the things that, one of the main things with it is having the asset showing the bank or the lender that this asset can cover the, the debt service that’s required on this, on an annual basis with the income. So how do you qualify for A-D-S-C-R loan? So investors can easily calculate if their property will qualify for A-D-S-C-R loan by calculating their DSCR and seeing if that meets the criteria set by the lender.

Charles:
And just make sure that your calculations include all the properties expenses, which with smaller rental properties are not usually accurately stated by the owner. About eight or 10 years back, I spoke to a broker about an off market property. It was like a 15 or 20 unit building and the seller didn’t include the property management expense in their numbers. And I acquired why this was, and the broker said, ’cause it was self-managed by the current owner. Well, A-D-S-C-R lender, or really any commercial lender for that matter, would add this expense into the underwriting, which would lower the NOI decrease the DSCR and a lower DSCR makes it hard to get approved for a loan. So make sure that when you’re going into before speaking to a bank or any type of lender anything, make sure that all the expenses are added in there because their underwriter will do that and that’s gonna throw everything off.

Charles:
And knowing that upfront and speaking to the seller about that, letting them know what kind of problem it is, it’s it’s an important conversation because you might need to get some sort of discount on the property if they’re not including all the expenses that are gonna be required to really operate that property in the future. A DSCR loan is a unique financing solution designed specifically for real estate investors where the property’s cash flow is factored into the loan terms. It can be suitable for many rental property investors or entrepreneurs, self-employed people, especially those who might not have adequate personal income to qualify for traditional mortgage. Now for investors with documented income, a traditional conventional mortgage might be best for them since the loan terms are typically more favorable to the borrower. So now you understand D SCR R loans, you have another type of loan product that you can possibly utilize for buying rental properties in the future.

Charles:
If you have any questions with these type of loans or any other type of lending or financing situations or solutions make sure to put them into the comments below. Please remember to rate, review, subscribe submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

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