Overview
A Debt-Service Coverage Ratio (DSCR) loan is a specific type of loan that businesses can use to finance the purchase of multifamily and commercial real estate. DSCR loans are unique in that they are based on the amount of cash flow a business generates each month compared to the amount of debt service payments the business must make.
In the commercial context, DSCR is used by lenders to determine whether a property will produce enough income to cover the monthly debt payments. This allows businesses with less-than-stellar credit ratings or insufficient collateral to secure financing.
Here’s what you need to know about DSCR loans if you’re planning to apply for commercial real estate financing:
Defining Debt Service Coverage Ratio (DSCR)
Before diving into the specifics of DSCR loans, it is important to understand what exactly DSCR is and why it is important.
Your debt service coverage ratio is defined as the “ratio” of cash available to “service” your debt.
In other words, it is a metric used to determine the amount of cash you have available to pay both the principal and the interest payments for your loan.
The ratio itself compares the target property’s net operating income (NOI) with the target mortgage debt service on an annualized basis (more on this below).
Your DSCR is important because it gives lenders valuable information about whether you (as the borrower) have access to enough cash flow to service your debt. A high enough DSCR provides some security to the lender that you’re unlikely to default on your loan payments.
How To Calculate Your DSCR
Calculate your DSCR by dividing the net operating income (NOI) of your property by the debt service of the loan (assessed on an annual basis).
Find your net operating income by subtracting all the reasonably necessary operating expenses of your property from the revenue that it generates.
The mathematical formula for calculating your DSCR =NOI ÷ DEBT SERVICE
Example of Calculating DSCR
Imagine you’re a developer who’s looking to get approved for a mortgage loan from your local bank.
Your bank lender will need to calculate your DSCR in order to determine your ability to borrow and pay off your loan while your rental property generates income.
You tell the bank lender that your NOI will be $2,000,000 per year. Your lender then notes that your debt service requirement will be $300,000 per year.
Based on those numbers, your DSCR will be about 6.67x.
That means you’ll be able to cover your debt service more than six times, given your operating income.
DSCR = 2,000,000 ÷ 300,000=6.667
Why Does DSCR Matter?
Your Debt Service Coverage Ratio matters because it is a financial metric that provides lenders with important information about the risk they assume with each loan they make.
The DSCR signals to lenders whether a borrower will be able to pay their debts for a commercial or multifamily property.
A higher DSCR will also give you more leverage (i.e. bargaining power) with your lender.
What Is A “Good” DSCR?
Most business lenders require their borrowers to have a DSCR ratio higher than 1.00. In fact, the minimum for most lenders is typically around 1.25.
A DSCR ratio of 1.00 means that the cash flow generated from the property in question will be exactly enough to service the borrower’s loan.
A DSCR ratio of 1.25 means that the borrower will be able to service their loan, with some added cushion.
DSCR Loans: How They Work
Borrowers can use DSCR loans to finance multiple different property types, including:
- Multifamily properties
- Commercial office spaces
- Hotels and resorts
- Private mortgages
The minimum DSCR number that lenders will allow will depend on the macroeconomic conditions. In a growing economy, lenders might be more willing to offer DSCR loans despite a lower DSCR number.
To avoid exposure to property types they might deem risky, some lenders only offer DSCR loans for certain types of property.
The amount of money you can get through a DSCR loan depends on the lender. Most offer loans with limits up to 3-5M dollars.
How To Apply for A DSCR Loan
1. Underwriting
Your lender will outline all aspects of the loan, including the loan’s value, terms, fees, and more. Your lender will also calculate your DSCR during this stage.
2. Documentation
DSCR loans will require you to fill out standard loan documentation.
Note that any financial documents you fill out for a DSCR loan will ask for information only about your business or rental property—not information that deals with your personal income history.
That’s because, by definition, lenders offer DSCR loans based solely on your Debt Service Coverage Ratio, not based on your personal financial history.
3. Submission and closing
Because they do not require information about your personal financial history, DSCR loans come with a much faster application and closing process than other types of loans.
Sample DSCR Loan Terms
| Maximum Amount for Loan | $4,000,000 |
| DSCR Minimum | 1.25 |
| DSCR Calculation (yearly) | DSCR =112 0006000 x 12 months = 1.56 |
| Term | 35 years |
| Amortization | 35 years |
| Interest Rates | 3.9% |
| Additional Fees | 20% upfront Lender Application fee – 0.2% loan Closing fee – 0.5% loan |
| Type of property | Multifamily (8 units) |
Pros And Cons of DSCR Loans
Like every other financing tool, DSCR loans come with their own unique set of pros and cons.
Pros of DSCR Loans
1. Lenders don’t consider personal income
Because DSCR loans don’t consider your personal financial information, they’re much more accessible to borrowers who might not have large amounts of liquid capital.
2. They come with faster application and closing times
DSCR loans typically come with a streamlined, fast application process because you won’t need to submit any personal financial documents or explain gaps in work history.
3. You can commit to multiple properties at once
Some loans force you to commit to one property at a time. They don’t let you take out a loan for a second property unless you’ve paid off your first loan.
DSCR loans don’t operate like that. Instead, they allow you to take out multiple loans at once for different properties.
Cons of DSCR Loans
1. Terms
Expect to pay anywhere from 20-25% of the total loan value as a down payment for your DSCR loan. You’ll need to pay lender and service fees, which can range from 0.5% to 1% of the entire loan.
2. Limited financing
Although DSCR rates and terms might be comparable to other loans, they often provide less overall financing. If you need more than around $5,000,000 for your commercial loan, DSCR loans might not be your best option.
Getting a DSCR Loan in Florida
DSCR loans let real estate investors in Florida qualify for financing based on their debt service coverage ratio—rather than factors like income and tax returns. Just like in other states, each lender imposes different qualification requirements, and available loan terms vary based on borrower qualifications.
If you’re looking for a DSCR loan in Florida, start by talking to a lender about your financing needs. They can help you determine if this type of loan is right for your situation and connect you with the right resources. Working with a lender familiar with the realities of commercial real estate in Florida may also streamline the borrowing process.
When you’re ready to apply, provide relevant information about the property you’re looking to finance, like a sales contract or appraisal. Also gather information about your existing loans and other necessary financial documents. If the lender approves you for financing, you’ll get a loan offer that outlines the interest rate, term, and amount.
DSCR Loan FAQs
Is it hard to get a DSCR loan?
DSCR loans are based on the future cash flow of your property, so qualifying is easier than with other types of loans. In fact, because approval for DSCR loans depends on your property’s income—not your personal financial situation—it can be much easier to get approved. What’s more, the application process is faster, more streamlined, and the requirements for DSCR loans are typically less stringent than for other types of financing.
Should I take out a DSCR loan?
DSCR loans can be a good option for some borrowers, but they’re not right for everyone. Ultimately, whether or not a DSCR loan is right for you depends on your individual financial situation.
For example, if you have a business or rental property that is bringing in a solid income, a DSCR loan may be a good fit. DSCR loans are also an attractive option if you can’t meet the personal income requirements of other loans. If you can meet these requirements, however, you may find more competitive rates or terms with another type of commercial financing.
Are DSCR loans expensive?
DSCR loans typically have higher interest rates than other types of loans, so they can be more expensive in the long run. Additionally, DSCR loans often require a large down payment—often between 20% and 25%—which can be difficult to come up with if you don’t have a lot of money saved up.
Final Thoughts
DSCR loans are a great option if you have a revenue-generating business or property.
Because they don’t deal with your personal income, they’re an accessible option for property investment.
Interested in applying for a DSCR loan? Loanbase has you covered.
Our platform streamlines the process of matching borrowers and lenders to help you, as a borrower, find the best deal.
We’ll match you with a lender who can meet your needs and help you get the best loan on the market. Start your property investment journey with us today.
