Often viewed as one of the least understood aspects of asset-based lending, DSCR is an essential tool for rent-and-hold investors. If you’re a landlord, you’re bound to hear the term DSCR while working with a real estate lender. DSCR, which stands for Debt-Service Coverage Ratio, can help you get a lower rate, or alternatively disqualify you from certain loan products when seeking investor financing.
DSCR: The Basics
From a lender’s point of view, DSCR refers to the borrower’s ability to pay back a loan based on the monthly rent of the property. Essentially, it is a way to measure cash flow. What’s tricky about DSCR is that each lender may calculate the number differently, and have their own minimum DSCR requirements.
With all these factors, it can be difficult to navigate DSCR, not to mention the landlord lending process, which is why we asked resident expert, Visio Sales Manager Brandon Foskey for his tips and tricks when it comes to financing using DSCR.
“Lenders are always looking for way to measure how likely a person is to repay their loan” Foskey said. “A good DSCR provides the lender with a little bit of reassurance that the borrower is getting enough monthly rent to cover their monthly mortgage expense.”
So what exactly is a good DSCR? Lenders tend to calculate DSCR differently, some more detailed than others. Visio for instance, uses a fairly simple DSCR calculation: the monthly gross rents divided by PITIA (monthly principal plus interest, taxes, insurance and association dues).
Because of these differences, there is no universal number required for a loan. The base DSCR requirement for a Visio Rental360, 30-year fully amortizing landlord loan is 1.2. There are some general guidelines to follow when seeking financing however.
“Anything above 1.0 means the investor is getting more rent then their monthly payment,” Foskey said. “Anything above 1.2 is usually considered a ‘good’ DSCR, and anything above 1.5 is considered a ‘great’ DSCR, with many lenders requiring a 1.2. The better (or higher) your DSCR is, the easier it is to obtain financing at the best rates.”
Some elements of DSCR are not within the borrower’s control, such as tax rates, market rents, flood zones, HOAs, etc. Foskey’s advice?
“Investors can improve their DSCRs a few ways: increase their down payment to lower their LTV (lower their loan amount), shop for insurance and try to get a lower insurance rate, strengthen their credit score to get lower interest rates and rehab the property into pristine condition so they can charge top market rent for the area,” he said.
Here are some more tips on how to keep your DSCR high:
- When you rehab the property do it right the first time. The better the rehab and the better the property shows the more rent you can charge.
- Pay your bills on time. Having good credit in this business and the ability to leverage your cash is crucial in building your real estate empire.
- Choose your investment areas carefully. Look at the market rents, vacancy rates, tax rates, insurance rates, flood areas, and local schools. Higher tax rates equal higher payments.
And remember, even if your DSCR ends up lower than you expect, it doesn’t mean that the property is a bad investment. There are many reasons to make a property investment—from a high-appreciating area to longer-term investment plans based on market trends.
“Understanding DSCR can make you a better-informed investor, but it isn’t the end all, be all,” Foskey said. “Trust your gut, and make sure your investment fits your strategy. You’ll come out on top.”