This article is presented by Easy Street Capital. Read our editorial guidelines for more information.
So far, throughout 2023, we have published several articles on DSCR (debt service coverage ratio) loans, a loan product that continues to grow in popularity among real estate investors. These included an overview of how to get the best rate and terms, how to use advanced strategies to maximize returns, and an overview of the new small multifamily DSCR loans niche, which expands the loan product to properties with up to 10 units! In May, we posted 12 Frequently Asked Questions (And Answers) About DSCR loans. This proved very popular and helpful for real estate investors exploring this transformative loan product.
More questions and advanced scenarios continue to flow and get discussed in the BiggerPockets forums, so we have decided to publish another installment to cover more of your questions!
1. I’m Not a U.S. Citizen. Can I Qualify for a DSCR Loan?
This is a question that is going to vary from DSCR lender to DSCR lender, but it is highly likely that you will find one that can lend to you. One of the challenges with qualifying as a foreign national is the lack of a credit score, which, as we covered in an earlier article, makes up one of the three key metrics (along with LTV and DSCR ratios) for determining qualification, rates, and terms.
In addition, DSCR lenders typically require “reserves” or a few months of PITIA (principal + interest + taxes + insurance + association dues) payments in liquid assets (typically cash accounts), and many foreign nationals don’t have these assets stateside and in U.S. dollars. Some DSCR lenders, though, will allow foreign nationals but will also typically come along with restrictions on LTV (limited to a maximum of generally 65% rather than a typical maximum of 80% under most DSCR programs) and a requirement for a U.S.-based bank accounts for reserves.
Finally, it’s important to note that this applies to true “foreign nationals” that are non-U.S. citizens and living abroad. Both resident aliens and non-resident aliens (i.e., “green card” holders) are typically fully eligible for DSCR loans with no LTV restrictions. Furthermore, one of the main advantages of DSCR loans is that borrowers are allowed to be entities, such as LLCs, partnerships, or corporations. Typically, if you are a foreign national that owns a portion of an LLC or entity alongside U.S. citizens, and your partner owns at least 50% of the entity and signs a full recourse guarantee, you should be able to qualify for a DSCR loan with no restrictions.
2. Can I Purchase a Property With a DSCR Loan and Fund the Down Payment With Seller Financing or Another Loan?
Generally, the answer to this question is “No.” Pretty much all DSCR lenders will not allow any other liens securing the investment property you are purchasing or refinancing. Part of the benefits of DSCR loans is that the lender is only evaluating your credit and the mortgaged property, not your global cash flows or DTI. This means that unsecured debt or mortgage loans on other properties in your portfolio won’t jeopardize financing. However, any additional debt related to the property you are securing with your DSCR loan is prohibited.
While some DSCR lenders will categorize everything with a DSCR under 1.00x as “no ratio,” some will separate near-1.00x DSCR loans, such as loans with DSCRs of between 0.75x and 0.99x as eligible and having ratios. These lenders would then call any DSCR loan with a DSCR of less than 0.75x as “no ratio.”
3. How Much in Reserves Do I Need for a DSCR Loan?
“Reserves” in the context of DSCR loans refer to documented liquid assets held by the borrower at the closing of the loan. Typically, DSCR lenders will require approximately six months of PITIA reserves to be documented. This provides the lender additional comfort that the monthly payments will be afforded by the borrower in case of interruptions in cash flow from the property (such as vacancies from leasing turnover or slow seasons for vacation or short-term rentals). The lender requirement will typically range from as little as three months (or sometimes even waived completely for specific scenarios like rate-term refinances when lowering monthly payment) to as much as nine or 12 months (extra may be required for very large loans or loans with a DSCR less than 1.00x).
4. Can I Use My Investment or Retirement Accounts for the Reserves Requirement?
Yes! Most DSCR lenders will allow the use of brokerage accounts (stocks and bonds) and even retirement accounts, such as 401(k)s, to satisfy the reserves requirement. While they will almost uniformly be allowed, the lender will typically utilize a “haircut” on these balances, which means they will reduce the amount that counts by 10 to 20%. For example, a DSCR lender may give you credit for $80,000 in reserves for a 401(k) retirement account with a portfolio value of $100,000.
Why do DSCR lenders use this “haircut?” It’s to account for the higher risk of stocks and bonds versus cash (these values can fluctuate, while cash stays stable) and also to account for the lesser liquidity (or the borrower’s ease of access to the funds). For example, if a borrower needed to actually use retirement funds to pay debt service on a DSCR loan, they will likely incur time and costs to sell the financial instruments, transfer the money, and may be liable for fees.
5. Can I Use Bitcoin or Other Crypto Assets for the Reserves Requirement?
Generally, most DSCR lenders will not allow digital assets to be utilized for the reserve requirements. However, this is a space that is still very new and constantly evolving, and one bitcoin and crypto-friendly DSCR lender does currently exist!
6. What is a “No Ratio” DSCR Loan
A “no ratio” DSCR loan typically refers to a DSCR loan in which the DSCR ratio (Rental Income divided by PITIA) is less than 1. It’s a bit of a misnomer since if the ratio is less than one (0.85x, for example), that ratio can be calculated and does exist, but it will still be typically referred to as “no ratio.”
7. Can I Qualify for a DSCR Loan if the Ratio is Less Than 1.00x?
Yes! While a DSCR loan with “no ratio” may sound like an oxymoron, it is not an obstacle to qualification for many DSCR lenders! Many lenders that allow loans with a ratio under 1.00x will typically require a 0.75x or 0.85x minimum. However, there are even some lenders that will allow true “no ratio” DSCR loans with no limits, even under 0.75x!
8. Why Would Anyone Invest in a Property With a DSCR Ratio Under 1.00x if it Means Losing Money Every Month?
Believe it or not, there are several situations where it makes sense, both for the investor (borrower) and the lender, to do deals in which there is a DSCR under 1.00x!
One example is for markets that have really high appreciation due to limited supply, booming growth, or other factors. Historically, these markets, such as those in coastal California or Austin, Texas, have earned investors gigantic returns through home price appreciation that far outstripped any minor negative cash flow. However, it’s impossible to predict the future, and there is no guarantee that those markets will still earn significant appreciation returns to make investing in them overall profitable.
However, from the lender’s perspective, at a low enough leverage point (typically 65% LTV or lower), it makes sense to lend on sub-1.00x DSCR to borrowers who want to gamble on appreciation, since if they default, there would be a low likelihood of the lender losing money since a foreclosure would cover the potential loan loss.
Additionally, there are other scenarios where sub-1.00x DSCRs “on paper” make sense for the investor. One of the main features of DSCR loans is that they are typically fixed rate and fully amortized for 30 years. That means the biggest expense on your rental property, the monthly debt payment, will be fixed for three decades. However, market rents typically increase every year, including a staggering 145% increase in rents over the 30-year period between 1990 and 2020 (from $447 to $1,096)! While taxes and property insurance rates grow as well, the monthly cash flow of a property held for 30 years and financed with a fixed-rate DSCR loan, will massively increase because while rental income goes up, debt costs stay the same. As such, investors with long time horizons will likely see great returns, even if they have negative cash flow in the first couple of years, which would be more than balanced out over time as market rents increase.
In addition, many real estate investors use the tried and true strategy of targeting properties with tenants paying below-market rents, and then once the property is purchased, increase the rents to market once the lease is up. DSCR lenders, however, underwrite the DSCR using the lower of in-place rent or market rent, so the DSCR on these properties could be negative if rents are well below market rate. In this case, these deals make a lot of sense for investors since they typically only need to wait a few months (out of a 360-month term) to re-tenant the property and start cash flowing. Here is another example of a “no ratio” DSCR loan that is only “no ratio” on paper and will provide cash flow and solid returns.
The flip side of this is if a property is rented at a rental rate well above the appraiser-determined “market rent.” In this case, the DSCR lender will still use the lower of in-place rent or market rent, creating a situation where the underwritten DSCR may be less than 1.00x, but the rent checks hitting your account every month tell a different story!
Finally, there are situations where there are DSCR lenders that are still extremely cautious when it comes to lending on vacation rentals or short-term rentals. A common methodology for these less forward-thinking lenders is to underwrite DSCRs based on the market rent the property would earn as a long-term rental, even if it’s optimized for short-term stays or in a vacation market dominated by short-term rentals. In these cases, the underwritten DSCR may be below 1.00x, but in the real world, the property would earn robust cash flow well in excess of the PITIA costs. Another case of deal-making sense for both parties despite “no ratio.”
Conclusion
Hopefully, this article helps your understanding of DSCR loans and how to evaluate investment property opportunities for which they can be best utilized!
This article is presented by Easy Street Capital
Easy Street Capital is a private real estate lender headquartered in Austin, Texas, serving real estate investors around the country. Defined by an experienced team and innovative loan programs, Easy Street Capital is the ideal financing partner for real estate investors of all experience levels and specialties. Whether an investor is fixing and flipping, financing a cash-flowing rental, or building ground-up, we have a solution to fit those needs.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
