If you want to acquire, develop, or construct commercial property, you’ll need to finance it through commercial real estate financing. Some examples of commercial property are office buildings, retail centers, apartment complexes, and industrial warehouses. As a business owner, you know that growing your business is always the goal; and one great way to do that is by purchasing or renovating real estate property.
But, in order to do either of them, you’ll need to get sufficient funds. In the following article, we’ll go through one of the most common loans business owners in the industry get, the DSCR loans, as well as their pros and cons.
DSCR Loans Overview
To understand DSCR loans, you first need to understand the debt-service coverage ratio (DSCR). It is a measure of the cash flow available to make mortgage payments, including taxes and insurance. The DSCR is important because it demonstrates to lenders that the investment will be financially stable and can generate enough income to cover its debts.
Commercial DSCR loans, for instance, are an option for both commercial and residential real estate that is held in an LLC. These loans are designed for real estate investors who can’t qualify for a loan based on traditional income verification methods. Instead of using their tax returns or W2s, a lender will use DSCR to qualify the borrower for the loan. Usually, borrowers with a DSCR of 1.25 and over are considered.
Commercial real estate loans with DSCR are frequently simpler to qualify for because investors in real estate can write off many expenses on their properties. There is also no limit imposed on the number of financed properties an investor in real estate can have using this type of loan.
Pros of DSCR Loans
No Need to Verify Your Personal Income
If you’re having a difficult time verifying your income, don’t worry. Since underwriters use future rental property income when approving loans, there’s no need for them to verify your personal finances.
New real estate investors and those who are self-employed often have difficulty demonstrating a high income on their personal tax returns, which makes it harder to get approved for a traditional mortgage. However, with a DSCR loan, you don’t need to verify your income, making it an ideal solution for anyone in this situation.
Will Not Get in the Way of Personal Finances
If you finance your rental property with a traditional mortgage, your monthly house payments will have to stay within your household budget. This could then limit how much money you can borrow for other personal needs in the future.
DSCR loans could help keep your rental property separate from your personal finances by allowing you to close in the name of an LLC, something most traditional lenders don’t allow.
Buy Multiple Properties at the Same Time
Basically, each rental property has its own financial support. This way, you can borrow for multiple properties at the same time and build your portfolio of homes more quickly.
Close the Loan Faster
Because the lender doesn’t have to evaluate your income and employment history, DSCR loans often close faster than regular home mortgages. With these types of loans, decisions are typically made quickly by private lenders who don’t have to deal with bureaucracy.
Cons of DSCR Loans
Requires Large Down Payments
Loan-to-value ratios go as high as 75% to 80% which. This means borrowers must put a down payment of 20-25%, which is a lot higher than the bare minimum for traditional mortgages where the down payment goes as low as 15%.
You May Experience Difficulties in Expensive Markets
If your new loan’s payment equals the rent you’re earning from the property, then that loan has a DSCR of 1.0. Most lenders want to see a higher number though, preferably between 1.25 and 1.5, which would mean that 25-50% more is being earned in rent than what is being paid as the loan’s monthly dues.
A lower DSCR means that you are more likely to not be approved for a loan because it would appear that you can’t afford the payments. Some lenders will offer 35-year or 40-year terms to lower each month’s loan payment and in turn, raise the DSCR. But be aware that longer loan terms accrue more interest.
Bottom Line
The DSCR loan is one of the most common types of loans used in commercial real estate financing. Its popularity is due to the many positive sides it has, and it can be used for a variety of property types. If you’re looking to finance your next commercial real estate venture, a DSCR loan may be right for you.
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