Real estate investors have long turned to private money loans when conventional mortgage lenders have determined that either they, with their multiple property holdings, or the properties they are looking to buy, pose too great a risk. But for its benefits of closing quickly and not involving an intrusive qualifying process based on ability-to-repay (ATR), hard money loans are expensive and most often have terms that require the investor to refinance or pay off the loan in the short term — not an ideal fit for those who own, or are building, a portfolio of rental properties and who are looking to stabilize their cash flow. Enter the DSCR or “debt service coverage ratio” mortgage. This unique program seeks to provide the investor with a way to qualify for the mortgage without focusing on personal tax returns and debt-to-income (DTI) ratios. These are conventional loans that look more at the property than the borrower — almost like a commercial or private money loan — but with the added benefit of more appealing terms.
Our DSCR or “DCR” (debt coverage ratio) mortgage is designed for borrowers who are experienced real estate investors looking to purchase or refinance an investment property that is held for business purposes. We qualify these borrowers based upon the cash-flow of the subject property and they are not required to provide additional employment or income related information — let’s emphasize this again. We are focusing on qualifying the property above the borrower. So where, in a traditional mortgage for a primary home, for example, we would be calculating debt-to-income based on the borrower’s paystubs and tax returns, and liabilities that carry over from the credit report, here we are looking at the cash flow of the property instead. Let’s dig in a little deeper.
Qualifying with Debt Coverage Ratio
The debt coverage ratio is calculated by taking 100% of the gross rents divided by the total monthly housing payment (PITIA) of the subject property. If a lease is in place on the subject property, we’ll use that number (with some exceptions) but if a lease is not in place, we’ll defer to the appraiser’s rent schedule. In order to qualify, our property must produce a DSCR ratio of greater than 1.0. So for example:
- Gross Rents = $3000
- PITIA = $2800
- Formula to determine DSCR: $3000 / $2800 = 1.07
- A 1.07 DCR is greater than the 1.0 requirement to qualify, so this property is eligible for approval.
- Gross Rents = $1900
- PITIA = $2250
- Formula to determine DSCR: $1900 / $2250 = .84
- Our DCR is .84 under the 1.0 requirement to qualify, so this property is NOT eligible for approval.
Both fixed rate and ARM programs are available to the investor on a DSCR qualification basis and this further expands the benefit of this qualification method. For those who own multiple investment properties and may not fit the qualifying criteria for a qualified mortgage (QM), the debt service coverage ratio alternative may be the solution you’ve been looking for. We’re here to help and answer any questions regarding your rental properties.
Come on in and cover me,
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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