DSCR Loans and Why You Should Consider them For Your Next Short Term Rental
A DSCR loan, or debt service coverage ratio loan, is a type of NONQM (non-qualifying mortgage) loan that is used to finance income-producing properties such as rental properties, commercial properties, and certain types of investment properties. The DSCR ratio is a financial metric that measures a property’s ability to generate enough income to cover its debt payments.
To calculate the DSCR, the lender takes the net operating income (NOI) of the property and divides it by the total debt service (loan payments). The resulting ratio is expressed as a percentage. For example, if the NOI is $100,000 and the total debt service is $80,000, the DSCR would be 1.25 (100,000/80,000). A DSCR of 1.25 means that the property generates 25% more income than the debt payments.
Lenders typically require a minimum DSCR ratio in order to approve a loan, which varies depending on the lender and type of loan. Generally, a higher DSCR ratio is considered more favorable and indicates a stronger ability to repay the loan.
A DSCR loan is useful for borrowers who want to purchase or refinance an income-producing property and want to use the rental income to repay the loan. This type of loan can be more flexible than traditional loans, as lenders may be more willing to consider alternative forms of income, such as rental income, when evaluating a borrower’s ability to repay the loan.
DSCR loans may be used for a variety of properties, such as single-family homes, multi-unit buildings, commercial properties, and more. They can be either fixed-rate or adjustable-rate loans, and have varying terms and amortization periods. It’s important to note that DSCR loans can be more complex than traditional loans, and you should be prepared to provide detailed financial information and have a good understanding of the rental market and cash flow projections.
Another thing to note on the DSCR loan is that many banks that offer this option will only use rental projections based off of appraised long term rentals. So if you are planning on using a DSCR loan on a short term rental property, ask your broker to make sure they use historical short term rental rates when calculating what the property can generate. This is especially important on Maui where most of the condos that are approved for short term rentals won’t make sense from a long term rental perspective, but will generate a healthy amount of income based off of short term rental rates. If the property is in a hotel zone the banks should absolutely take into account short term rental rates.