Use DSCR Loans to Grow Your Rental Portfolio in California

Property investors in the Golden State 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 expenses including principal, interest, taxes, insurance, and association dues (PITIA). 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, also known as non-QM 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.

California DSCR Loans Look at Cash Flow Rather than Personal Income

Conventional 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. Even if their income history is strong, their personal income usually cannot cover all the debt of multiple loans.

On the other hand, for a DSCR loan, investors don't need to worry about providing prior tax returns or income verification. DSCR loans have qualifications based on a minimum credit score and are underwritten using the property's income potential.

DSCR Loans in California Offer Flexible Terms and Fees

With a DSCR loan, borrowers can purchase an investment property with the benefits of full 30-year terms and 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.

California DSCR Loans Have More Flexible Common Sense Limitations on Number of Mortgaged Rental Properties

For the professional investor looking to build a large real estate portfolio, a DSCR program is ideal. Most 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.

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DSCR Calculated and Optimized

To calculate DSCR, use this simple formula:

DSCR = Rent / 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 $1,800 per month and your rental income is $1,800 per month, you are breaking even. A good DSCR ratio is a 1.2 or higher. If your debt-service coverage ratio is too low, there are some simple ways to optimize it:

Increase your down payment. Raising your down payment is the simplest way to improve debt-service coverage ratio. This will lower your rate, and therefore your monthly expenses and DSCR.
Negotiate your taxes and insurance. By fighting your property taxes and lowering your insurance payments, you can bring down your debt-service coverage ratio.
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.
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.
Provide upsells to increase rental rates. If you are able to increase the subject property income by providing upsells, such as renting to pets or providing a furnished rental, this will help you optimize your DSCR.

How to Qualify for a DSCR Loan in California

DSCR loan qualifications vary based on lender. However, here are some standards you can expect from most lenders to qualify for a DSCR loan:

Minimum Credit Score: Usually a 680 or higher.
Loan amounts: Usually a minimum of $75k and a maximum loan amount of $2 million.
Minimum LTV: Sometimes you can get up to 80% to purchase property, however for cashout loans, the minimum is typically 75%. A good rule of thumb is to have a down payment of 25% at the very minimum, higher is better.
Minimum DSCR: Typically, you'll need a 1.2 to show that the rental income is higher than the mortgage payment. However, some lenders offer a No DSCR loan program in hot markets where the rents have not caught up to the home prices.

The California DSCR Loan Process

The DSCR loan process is much simpler than the traditional mortgage process. Let's break it down in three basic steps:

Step 1: Complete the DSCR loan application.

Apply for your DSCR mortgage loan and pay for an appraisal.

Your loan officer will get your credit evaluated to make sure you meet the minimum credit score qualifications.

Step 2: Move into processing.

Once your application is complete, your DSCR loan will move into processing.

DSCR mortgage processing is relatively simple since the lender is mostly looking at the rental property quality and rental income potential. No tax returns, no pay stubs, and no personal income history.

Step 3: Close and get funds.

Once your DSCR loan is processed, it will move into underwriting and quality control.

From there, it will be funded. You'll pay your down payment and closing costs, and then receive funding.

California Real Estate Investors See High ROIs

Despite a higher entry point, Mashvisor finds California a worthwhile rental property market due to its employment opportunities, increasing property values, and high rental demand.

In fact, the California Association of Realtors (CAR) reported that home prices are expected to increase 5.3% in 2023. This means that simply by purchasing a property in California over another state, you will see a higher ROI through appreciation.

Los Angeles is our number one city to originate DSCR loans in California. According to FortuneBuilders, Los Angeles is a great city to purchase investment properties with rental income on the rise and home ownership becoming increasingly cost prohibitive. The median rent is $2,644, and it's growing at an 11% pace year-over-year.

Here are some additional cities where Mashvisor recommends looking for rental properties in California:

Thermal, CA: This California city boasts a $424,170 median property price, an $1,800 average monthly rent, and a 4.93% cash return.

Alterna, CA: Offering over a 7% cash return, this city has an affordable entry point at a $387,583 median property price. Plus, the average monthly rent is over $3,000.

Corning, CA: Corning is another great California town to invest in with a median property price of $411,750, and an average monthly rent of $2,253. That’s a 4.7% cash return.

Pomona, CA: Nearby the Claremont Colleges, Pomona has a median property price of $658,000 and an average monthly rent of $2,756.

Anaheim, CA: Home to Disneyland, Anaheim has a higher median property price of $825,103, yet also a high earning potential with an average monthly rent of $3,397.

If you're investing in short term rentals, Mashvisor recommends looking at San Diego, Malibu, and San Bernardino.

Popularity Soars for DSCR Loans California

DSCR loans have become increasingly popular over the last several years for a variety of reasons. One reason is that capital markets have grown widely comfortable with non-QM loans, including jumbo loans, bank statement loans, foreign national loans, and asset based loans like DSCR loans. According to CoreLogic, the non-QM share of the national housing market doubled from 2020 to 2022 and accounted for 4% of the mortgage market in 2022.

Another key reason DSCR loans are on the rise is that the lack of mortgage loan affordability and low inventory are driving a trend toward rentership. California has the second lowest homeownership rates in the country and only 56% of households own the home they live in (Source: PPIC). The demand for rental properties is high and the rent prices cover the debt obligation on a given property. This makes DSCR loans excellent loan options for California investors.