Want to purchase an investment property without having to verify your personal income? A debt service coverage ratio (DSCR) loan might be your solution. With this financing option, lenders measure the cash flow of a property in comparison to its debt obligations.
Keep reading to learn everything you need to know about DSCR loan programs, including how they’re calculated and their influencing factors. Want to skip ahead? Jump to one of these sections:
- Understanding DSCR Loans
- How DSCR Is Calculated
- Types of DSCR Loans
- Why DSCR Matters
- Factors Influencing DSCR
- How to Improve DSCR
- Risks and Considerations
Understanding DSCR Loans
A DSCR loan is used to assess an individual company’s overall financial health. Typically, the measurement indicates how much cash flow a real estate investor has available to pay for their current debt obligations. The debt refers to any scheduled forms of payment they owe to anyone. Some examples of these written and signed contracts include rent, mortgages, student loans, car loans, personal loans and timeshares.
Many real estate investors prefer DSCR loan programs because they don’t require large down payments. Also, instead of basing the loan on a real estate investor’s personal income and creditworthiness, it’s based on the property. That means a property must generate enough revenue to cover the financing payments. With this minimized risk for lenders, the loan is more likely to get approved.
How DSCR Is Calculated
To determine your DSCR, you can divide your net operating income (NOI) by your debt. For example, an investment property generating an annual NOI of $50,000 with an annual mortgage payment of $40,000 would create a DSCR of 1.25, meaning extra income is available. Any DSCR above 1.25 is considered strong.
On the other hand, a DSCR below 1.00 could indicate financial difficulties. For example, an annual NOI of $50,000 and an annual debt payment of $55,000 would create a DSCR of 0.90, meaning more income is needed to cover the loan for your property or project services.
Types of DSCR Loans
Do you want to purchase a new office, buy a whole franchise or finance a public service project? Discover the right loan for your business-related goals.
1. Commercial Real Estate Loans
Commercial real estate loans are designed to finance the purchase of a property used for businesses. While holding your real estate in an LLC isn’t a requirement, doing so helps demonstrate the loan is used for business purposes. Instead of using W2s or tax returns, a lender uses the DSCR to qualify a borrower for the loan.
2. Business Acquisition Loans
Business acquisition loans are designed to finance the purchase of an existing business or franchise. The amount you can borrow and the DSCR loan requirements vary per lender.
3. Project Finance Loans
Project finance loans are designed to finance long-term services for companies and governments. Lenders measure a DSCR by taking the net operating income and dividing it by the total debt of the services.
Why DSCR Matters
From a lender’s perspective, an applicant with a strong DSCR indicates their financial stability and ability to pay off a loan. Any low scores may indicate a risk of the loan not being paid back. Lenders may mitigate that risk by not approving the finance plan.
From a borrower’s perspective, calculating your DSCR lets you know whether you are financially stable enough to purchase a commercial property or pay for long-term services with financing. Having a strong DSCR ensures sustainable debt. As a result, you can feel confident moving forward to get the loan.
Factors Influencing DSCR
DSCRs are essential for loan approvals and ongoing planning within a company. The internal check for financing involves many components, including:
- Operating income: Total income is determined by how much your business generates from operations. Lenders consider how a successful purchase of property or an increase in services would generate more revenue, which influences the DSCR.
- Total debt service: Total debt is determined by your loan repayments and related interest. Any debt your organization must pay within a given period influences the DSCR.
- Loan terms and interest rates: Longer loan terms and lower interest rates can reduce the amount of debt your business pays. By impacting your monthly or annual payments, these factors can change your DSCR.
- Market trends and economic conditions: Market demand, competition and inflation can impact the operating income of your business. As a result, these economic factors influence your DSCR.
How to Improve DSCR
Since a DSCR mainly revolves around your income and debt, you’ll need to strategize how you can boost your profits. Increasing your revenue and reducing your debt helps raise your DSCR.
Consider how you can cut expenses. Can you reduce labor costs with automated processes, or can you get lower inventory prices by negotiating with vendors? To reduce your debt, can you refinance your current loans to lock in a lower rate?
Save time and effort when you invest in financial planning services to help you raise your DSCR. Working with financial advisors offers a way to gather valuable information and enhance your business strategy.
Risks and Considerations
Before getting a loan for your real estate investment or project services, you should consider the following:
- Market volatility: Are prices steady or unpredictable? Complete some research to determine if you should invest now or get a loan later.
- Economic uncertainties: Are there any risks such as market fluctuations, changes in government policies, political instability or natural disasters? Evaluate how current conditions might impact business-related strategies and public projects.
- Due diligence before applying: Can you verify that the information you submit to a lender is accurate and free of red flags? Have proof of your business-related income and debt with any required documentation.
- Understanding loan terms and conditions: Have you learned about the loan terms regarding limits, down payments, interest rates and lender fees? Prepare to get a financing plan by researching the terms and conditions to see if they align with your goals.
Learn More About DSCR Loans for LLCs
Want to purchase commercial real estate with a DSCR loan and a low down payment? Or do you want to kickstart a public project with financing options offering low interest rates? Homesite Mortgage is a trusted lender that can help you achieve your business-related goals.
Our regional team consists of licensed bankers, skilled loan processors, experienced underwriters and efficient loan closers. When you work with us, our professionals ensure you have a great experience. We can answer your questions and discuss financing solutions that suit your needs.
Applying for our financing is simple and quick. We offer an online process with advanced technology to save time and secure your personal data. Typically, we close loans within 18-20 business days.