Property investors across the state of Arizona are using debt service coverage ratio (DSCR) loans to expand their portfolios. DSCR is calculated by taking the monthly rental income and dividing it by the property's monthly payments including principal, interest, taxes, insurance, and association dues. The final debt service coverage ratio is essentially an indicator to the lender of a borrower's ability to repay their loan. Many lenders have a minimum DSCR of 1.2, which indicates positive cash flow.
DSCR loans are ideal for self-employed investors or investors with large portfolios. Their simplified approval process and loan terms are designed specifically for real estate investors. Let's take a closer look
Traditional loans focus heavily on debt-to-income ratio (DTI) and require substantial documentation including pay stubs, bank statements and tax returns. Meeting debt-to-income ratio requirements can be tricky for investors with multiple mortgaged rentals. On the other hand, DSCR loans have qualifications based on a minimum credit score and are underwritten using the property's income potential.
With a DSCR loan, borrowers can take advantage of full 30-year terms with no balloons. Most DSCR lenders will also have the optionality for interest only loans, rate buy- downs, prepayment penalty buy downs, and rate structure choices. It is great for investors to be able to tailor their DSCR loan program to meet their investment needs. For instance, investors planning to hold onto their rental property long term can choose a fixed rate and pay higher fees, while investors who might sell in the near future can select an ARM rate structure and buy down their prepayment penalty.
For the professional investor looking to build a large real estate portfolio, a DSCR program is ideal. Most traditional lenders max out borrowers at ten loans. Instead, when evaluating qualifications for a DSCR loan, lenders will use common sense to evaluate an investor's maximum credit exposure.
To calculate DSCR ratio, use this simple formula:
DSCR = Rent / Principal, Interest, Taxes, Insurance, Association Dues (PITIA)
A debt-service coverage ratio of 1 indicates that the monthly expenses of a subject property are equal to the monthly expenses. For instance, if your monthly expenses are $1,875 per month and your rental income is $1,875 per month, you are breaking even. A good DSCR ratio is a 1.2 or higher. If your DSCR ratio is too low, there are some simple ways to optimize it:
1. Increase your down payment. Raising your down payment is the simplest way to improve DSCR. This will lower your rate, and therefore your monthly expenses and DSCR.
2. Buy down your interest rates. Some DSCR lenders will provide you with the opportunity to buy down your rate. This will increase your closing costs, yet decrease your monthly payments and debt-service coverage ratio.
3. Increase rents. If you do not already have a lease agreement in place, consider raising the rate to increase the amount of monthly cash flow and, therefore, debt-service coverage ratio.
4. Provide upsells to increase rental rates. If you are able to increase the rental income by providing upsells, such as renting to pets or providing a furnished rental, this will help you optimize your DSCR.
According to NuWire, Arizona’s growing population, strong economy, and great weather make the state ideal for investors. Not to mention its $240,000 median home price makes the state affordable.
Phoenix is the number one Arizona city where we originate investment property loans. RentCafe reported the average rental income is $1,590, and the city is 44% renter-occupied. A close second in loan origination volume for us in Arizona is Scottsdale. Not to far from Phoenix, Scottsdale is slightly more expensive with an average rental income of $2,087. There are also less rental properties with a 33% rental occupancy rate (Source: RentCafe).
If you’re considering buying rental properties in Arizona, here’s where NuWire recommends you look in addition to Phoenix and Scottsdale:
Tucson: This family-friendly town has a cost of living well below national average, as well as wonderful public schools.
Tempe: Home to Arizona State University, Tempe has an abundance of college renters. The city also has a booming job market.
Mesa: Not too far from Phoenix, rental homes get taken off the market quickly. Plus, the entry point is affordable with a median sale price of $300,000
Check out some of our recently closed DSCR loans in Arizona.