Today, we're going to be talking about debt service. coverage ratio loans also known as dscr loans and how they can help you scale your real estate investment portfolio so even though it may be easier to get a loan whole concept of a dscr loan itself is a little bit confusing because many people have not gotten one before my name is sean and i make real estate easy and for several years i worked as a full-time hard money lender and originated millions of dollars of this special type of loan so in today's video i'm going to be going over how dscr loans work why you would want to get one and my insider tips on what you can do to get the best rates So let's get into it. So first of all, let's talk about why you would want a DSCR loan. If you were to buy a home with a conventional loan from any large bank, they're gonna ask you for your W-2s, tax returns from the past two years, and base the amount you can borrow based on your debt to income ratio.
They'll wanna know about every other property you own, and they'll limit you to 10 loans per person because they think that real estate investors with over 10 properties pose a high risk. So if you have a lot of properties and you want another loan, you typically have to pay off old loan or sell another property off first. With the DSCR loan on the other hand, It's more about property itself than about your own personal income.
And this is because these special lenders know that not all real estate investors have full-time jobs. So they're going to be looking at whether the property market rents can cover the debt service and expenses. Now, the downside to a DSCR loan is that since it is non-traditional financing, the rates are going to be a little bit higher.
So when rates are like 6%, 7% for normal rental, you might expect 8% less origination and processing fees for a DSCR loan. So now that you know a little bit about what they are, where can you get a DSCR loan? Most big banks will not offer these type of loans, but most hard money lenders will.
Something to note is that not every lender can lend in every single state. In fact, if you guys are looking for a DSCR loan, you can click on the link in the description and fill out the form, and someone from my old team will reach out and give you a quote. And when it comes to the application process, here are some of the questions that they're going to ask you. They're going to want to know your name, contact information, your approximate credit score, property address, and what the current market rates are, what your estimated property tax will be, and the insurance costs.
From this information, they can do their own back-end calculation to see if this deal makes sense in the first place. Then they're gonna order a full appraisal on the property to confirm the value of it, and they're also gonna get their market rents from this appraisal. This is part of their due diligence process to check and see if this is something that they wanna lend on or not.
Now for eligibility requirements, again, they don't care about your income per se, but they do wanna make sure that you have enough in savings to cover the down payment, closing costs, and six months of the PITIA, which is the principal, interest, taxes, insurance, and HOA dues, if any. Most lenders will only give DSCR loans for one to four unit properties, condos, and townhouses, but some of them may go up to 12 unit properties so talk to your lender and see what they can lend on your credit score is also going to be a huge factor in determining your rate and how much leverage they can give you in the first place so most dsco lenders can only go up to 80 of the purchase price for single family homes and only up to 75 for two to four unit properties and 70 for commercial properties which is five to twelve units dscr loans also typically take around the same time frame that a normal loan would because they have to go through the full appraisal process so it's not going to be as fast or flexible as a hard money loan so expect to close around 30 days so now you know what they are and how they qualify you let's look at how dscr loans actually work again dscr means that service coverage ratio so the way that you calculate your dscr is by taking your gross market rent number from your property and dividing it by that p-i-t-i-a number and here every lender does a calculation a little bit differently as well but the firm that i worked at they were looking for a dscr ratio above 1.15 which meant that your rent payment needed to be over 1.15 times your p-i-t-i-a now this makes sense because your p-i-t-i-a it's a number that you're gonna have to pay no matter how well your property performs and in reality there are gonna be unexpected expenses you are gonna have some vacancies so if your DSCR is lower than 1.15 out of the gate you're probably gonna end up with a cash flow negative property so here's give an example let's say you have this property with a mortgage as an example let's say you're buying a $200,000 property with a 75% LTV 30-year fixed mortgage at 7.5% interest so that would make your mortgage $1,049 a month if we assume insurance is a $101 a month and property taxes are $250 a month with no HOA dues, then your total PITIA will be $1,400. So this means that your market rent from this property needs to be $1,610 or higher. And like with any other loan, what's going to happen is when you're under contract for a property, you're going to put in your earnest money deposit first to show the seller that you're serious.
This is typically going to be 3% of the purchase price. All of your required payments are going to be managed by the escrow company. They're going to tell you a bank account where you can transfer your funds and they'll handle the transaction on your behalf. half so there's no need for you to send money directly to the seller all right so now that you know how DSCO loans work let's talk about how they're priced every lender is gonna have a special rate sheet and matrix determines how they're gonna price your loan most letters are not gonna share the sheet publicly because they didn't want the competitors to see how they're charging everything but by using the sheet the loan officer will be able to change the interest rate based on the different factors such as your credit score as well as what your loan to value ratio is so if you have a property that's worth five hundred thousand dollars and you want to get 75% of that as a loan amount That's going to be a higher interest rate loan than if you only want 50% of the loan amount.
Because from a lender's perspective, the loan is safer if you have more skin in the game and a higher down payment. Now that being said, there are also different variants to a DSCR loan. You have your traditional 30-year fixed loan, which means that for 30 years, you stay with... the same interest rate and over those 30 years you'll have paid off your entire loan as well as any interest but there are other variations such as a 7-1 arm or a 5-1 arm so this stands for adjustable rate mortgage the first number is going to be how long the initial rate is fixed for and in the slash one number means that every year after that, the rate will change. So for a 7-1 arm, it means that for the first seven years, your rate is gonna stay the same, and then it's gonna adjust to a new market rate every single year after that.
So the benefit of doing this is that you typically have a lower rate with a 7-1 arm and a 5-1 arm than with a 30-year fixed loan. But the downside is, if you start your loan when interest rates are really low, and then they skyrocket, as you've seen recently, then for the first seven years, you're gonna have your low interest rate, but then every year after that, it's gonna readjust and pop up to whatever it is now. Since DSTO loans are more flexible, you're then- Lenders can make adjustments based on your specific needs in exchange for higher pricing. So some lenders will do a DSC or a loan under one, which means that you will be cashflow negative, but they're gonna charge you way more on your rate and they're only gonna give you up to 65% of your purchase price.
You may also have to pay a premium depending on what state your property is in because different states have different regulations and different risk factors. Now this changes all the time. So again, talk to your lender and see which states cost more to do loans in. They may also charge you more if you're trying to do a cash out refinance.
A cash out refinance is whenever your new loan is larger than your- current loan and you're getting more money to put back into your pocket and if you're a foreign national meaning that you're not a US citizen you're gonna get charged a higher rate now I know that's really interesting about GST loans is that you have the option of lowering your interest rate or increasing your interest rates depending on what prepayment penalty you choose for your loan prepayment penalty is basically saying that if you refinance pay off the loan or sell your house before a certain time frame then you're gonna have to pay extra for doing so and this is because non-traditional lenders want to keep their investments secure they don't go through all the trouble of letting out their money and originally loan thinking that they're making a certain percentage every year only for the bar to go around and sell the property or refinance early cutting them off from their interest payments so that's why they set up prepayment penalties so if your kid was holding on to the property and you don't plan on selling or refinancing for a long time then you should opt into the highest prepayment penalty to get the lowest interest rate now there are two types of prepayment penalties there's a points version and the minimum interest version and the difference here is staggering so pay close attention so when we refer to the points version it typically follows a step down phase so for example if you have a three-year prepayment penalty with points then if you sell the property within the first year, you have to pay the fee equivalent of 3% of the loan amount. If you sell the second year, the fee drops 2% and the last year it drops to 1%. So again, as another example, let's say you had a penalty last for seven years, that's points version. The first year you have to pay 7% of the loan amount.
The second year you pay 6%, third year 5%, so on and so forth, till the seventh year where you pay 1%. So yes, 7% of a loan amount may sound like a lot and it is, but it's definitely not as bad as the next one we're going to talk about, which is minimum interest. A pre-payment penalty through minimum interest. minimum interest basically means that you owe this lender whatever interest you were going to pay for those seven years no matter what.
Trust me this adds up to way more than a simple five percent of your loan amount. So just to compare the two let's have an example where you had a loan amount of $200,000 for seven years and your first one was three points. So if you sold this on year one then you have to pay seven percent of your loan amount as a prepayment penalty which is $14,000 which hurts a lot. But if you go the minimum interest route then you have to pay seven years worth of interest which is $94,065.65. ouch so make sure to only choose the minimum interest option if you're absolutely sure that you won't sell or refinance during that time because if you do it can end up costing you a lot and finally another adjustment with dsr loans is if you want to go with a 10-year interest-only program so this is something pretty unique to dsr loans where they may give you the option of having you only pay interest on your loan for the first 10 years and then have it automatically convert to a 20-year mortgage afterwards so it's still a 30-year loan just that your first 10 years are interest only and then it becomes a 20-year loan afterwards now this is super, super helpful for people who are buying a property that may not cash flow well today because by going with an interest-only loan, your DSCR looks a lot better.
So you can get lower rates on it and you're gonna have less monthly payments because again, you're only paying interest for the first 10 years and you don't have to make any principal payments. So I know a lot of clients who absolutely loved it when I gave them the option, but you do have to pay a slightly higher interest rate to do it. Now, one thing to know about DSCR loans and people who are trying to do the BRRRR strategy, who wanna cash out refinance as soon as possible, is that most DSCR loans have a seasoning requirement. that may affect how much money you can actually pull out. So for example, if you're buying a property and you wanna do a cash out refinance within three months of buying the property, then you're gonna be limited to 75% of the loaned cost, meaning 75% of your purchase price plus any renovations you made or 75% of the appraised value, whichever is lower.
So as example, let's say you bought a fixer-upper for $100,000 and spent an additional $50,000 on renovations. So this means your total cost is $150,000. So now imagine that the house is in a really nice area and the value has increased to $400,000. So you may be thinking, okay, I did the Burr's strategy, I put in $150,000 and now that's worth $400,000, I can get 75% of the $400,000 because that's what the value is.
But unfortunately, because of seasoning requirements, you're going to be limited to 75% of the $150,000 that you put in. So it's not that great. Now, the second phase of seasoning requirements applies if you've owned the property for more than three months, but less than 12 months.
So in this case, you're going to be limited to refinancing either 100% of your total cost or 75% of the property's current value, which is lower. So again, an example, if your total cost was $150,000. and the property's value is now worth $400,000, then you can only get up to $150,000 because that is 100% of your total cost, which is lower than 75% of the property's current value. Then after 12 months, there is no more season requirements and you can do a cash out refinance for up to 75% of that $400,000 number. So I know that was a lot.
And now that you know how things are priced, here are some tips to get the lowest rate. So number one, get your credit score up as high as possible. The company that we used to work for used to break up their tiers from every 20 points.
So someone at 680 to 689 had different pricing than someone who had 700 to 719, all the way up to 780 credit score. Number two, get a lower LTV if you can. But if you do, make sure they're all in 5% increments. So the buckets are from 60.01 to 65%, 65.1 to 70%, and 70.01 to 75%.
So number three, make sure the DSCR of the property is higher than the 1.15 ratio, and your loan amount is between 100,000 and 1.5 million. So that way you're in the normal range and don't need to be charged more. Number four. try to use a DSCR loan to purchase properties or refinance instead of doing cash out refinances because cash out refinances cost more. And also try to buy single family houses with them because again, multifamily properties, condos, and townhouses cost more as well.
And number five, go with the highest prepayment penalty program that you can handle. So DSCR loans are great for real estate investors who fall into the specific category of not being able to qualify for conventional loans, but have great credit scores. But if you're an investor with overtime loans, you can't get more loans from the bank or the bank.
is denying you because you don't have enough income to support another property, then these loans are great for you. Now, if you guys are looking for a company, I highly recommend checking out Conventus Lending. They are a nationwide lender. And if you fill out the pre-screening questionnaire with the link down below, a loan officer will give you a call and get back to you to go over the details of your deal and give you a very competitive quote.
And if you let them know that you came to this channel, they'll even give you a discount on your processing fees. Now, if you guys are in the market for a fixer-upper and you need to close quickly, then make sure you check out this video to find out exactly how hard money loans work. Thanks for watching.
I'll see you next time. Take care.