Getting the Best DSCR Loans for Your Rental Properties
If you’re a real estate investor, you want to make the most of your properties. But first, you have to be able to afford them! This can often be a difficult task, requiring all kinds of financial structures, loan considerations, and income criteria. For investors of short-term and long-term rentals, these can be a headache.
Fortunately, there is an alternative. The loan specialists of The Mortgage Shop have been helping investors, for over 15 years, successfully secure the perfect Debt Service Coverage Ratio (DSCR) loans for their projects.
With the appropriate debt service coverage ratio loans, real estate investors can put the standard mortgage hassles and headaches behind them and get started on what they love most: making money through cash flow!
So, What Exactly Is Debt Service Coverage Ratio, Anyway?
Whether you’re investing in short-term rentals, long-term rentals, or vacation rentals, you’ll be faced with various financial obligations. You may have debt obligations. You’ll have operating expenses and principal payments.
This is where the debt service coverage ratio comes into play. Your debt service coverage ratio (DSCR) is the ratio of your property’s income to its debt. It is a vital ratio for calculating debt payments and net operating income to determine your qualifying financial health.
What Your Debt Service Coverage Ratio Specifically Means
Are you wondering: what is a good debt service coverage ratio?
An acceptable debt service coverage ratio is usually anything at 1 or higher. If the ratio is 1.25, that means you have 25% more income than is required to cover your mortgage debt.
This ratio not only gives you a good idea of whether you’ll be financially stable, but more specifically, tells you how much money you’re bringing in relative to how much you’re putting out.
Real estate loan experts, like those at The Mortgage Shop, deeply understand the debt service coverage ratio. With the help of seasoned specialists, investors can enter into debt service coverage ratio mortgages that perfectly fit their needs.
If you’re wondering how these debt service coverage ratio loans differ from traditional loans, you’re not alone.
Debt Service Coverage Ratio Mortgages vs. Qualified Mortgages
Your typical so-called qualified loan is a loan backed either privately or by the government. Those backed by private institutions such as banks and credit unions, but not by the government, are called conventional mortgage loans.
Generally, qualified lenders typically impose certain income statement requirements, oftentimes requiring personal financial statements. These verification standards can often limit an individual’s or company’s ability to invest.
However, debt service coverage ratio loans are different.
Debt Service Coverage Ratio Loans Allow Greater Flexibility
Unlike a qualified mortgage loan, debt service coverage ratio loans do not apply the standard benchmarks of financial health. Rather, investors must instead provide information on the expected cash flow statement of a property. In other words, its financial performance.
Financial institutions that lend debt service coverage ratio loans will closely analyze real estate investors’ net operating income (NOI) and the outstanding debt of the mortgage. Through this analysis, lenders will decide whether or not the investor has enough net operating income (NOI) to cover applicable long-term and short-term debt.
This is how institutions know you have enough income, specifically enough operating income, to make the principal payments and interest payments required.
The Role of NOI in Debt Service Coverage Ratio Loans
Remember, the debt service coverage ratio is the ratio of the property’s annual NOI to its annual mortgage debt. Although an individual or company’s debt payments may include other current debt obligations, the debt service coverage ratio only factors mortgage debt and net operating income.
If you’re an investor seeking long-term, short-term, and vacation rentals, your NOI can vary widely between properties. To calculate your net operating income, think of it as your net income. This net income and net profit are terms sometimes used interchangeably, but not always.
Regardless, consult a loan expert about calculating any debts, principal repayments, loan payments, and important financial ratios. Without a strong grasp of your NOI, you may miss out on critical debt service coverage ratio loans.
Contact the experts of The Mortgage Shop for help with all your debt service coverage ratio needs.
How to Calculate Annual Net Operating Income (NOI)
As you calculate your debt service coverage ratio (DSCR ratio), you’ll need to know your precise annual NOI. The formula for your NOI is as follows:
NOI = Gross Operating Income – Operating Expenses
Before you can ever receive a debt service coverage ratio loan, you need to know this NOI total.
Calculating the Gross Operating Income of Your NOI
Firstly, begin with your gross operating income, which is your potential rental income minus vacancy rates. Your potential income is how much you would make with 100% occupancy, 100% of the time. Because this rarely happens, you have to subtract vacancies to obtain the actual rental income.
Once you’ve totaled all these lease payments, you have your gross operating income.
Now you need your operating expenses.
Calculating the Operating Expenses of your NOI
An individual or company’s ability to cover expenses is critical to that individual or company’s financial health. As such, you need to know your operating expenses before you can calculate your NOI.
These expenses are typically associated with:
- Property Tax
- Property Management
- Maintenance and repairs, and
- HOA fees
Once you know these expenses in the annual total, subtract that number from your annual gross operating income to calculate net operating income (NOI). With your NOI determined, you can now move to the final step in the DSCR calculation: figuring out your total debt service (TDS)
The Role of Annual Debt Payment in Debt Service Coverage Ratio Loans
In determining an individual’s or company’s financial health in terms of debt service coverage, we need to know what is called the total debt service (TDS). This annual debt service is essentially the sum of all annual debt payments. This includes principal repayment and interest repayment.
It is important to make a distinction between TDS and its ratio (TDSR). The ratio is expressed as a percentage and will often cover ancillary expenses – housing and non-housing, such as vehicle and student loans.
Calculating The Annual Debt Payments for your TDS
In the case of finding your debt service coverage ratio, we are concerned only with the TDS, not the ratio. The TDS can be calculated using the following formula:
TDS = (Interest × (1−Tax Rate)) + Principal
For instance, let’s say your interest is 8% on a principal of $300,000, or $24,000, and your income tax rate is 32%. So, your formula would be: TDS = (24,000 × (1−.32)) + 300,000. In other words, TDS = 16,320 + 300,000, or $316,320.
With this TDS figure, you can now determine your debt service coverage ratio. For example, if your net operating income (NOI) is $500,000, simply use the formula: Net Operating Income (NOI)/TDS, or 500,000/316,320 = 1.58
What is a good debt service coverage ratio, you ask? Well, the resulting debt service coverage ratio of 1.58 is good! This ratio indicates you have 58% more income than is required to cover your annual debt service.
Nonetheless, you should always consult a leading mortgage broker and loan specialist before calculating DSCR. The experts of The Mortgage Shop will help you meet all applicable criteria, whether it be a strong debt service coverage ratio, a practical down payment, a healthy credit score, or anything else.
Interest Payments and the Interest Coverage Ratio
Another important ratio to consider as part of your annual mortgage payment and debt service coverage ratio is the interest coverage ratio. Often, borrowers may be caught off guard. If they don’t fully plan and understand their future finances, interest rates can bog them down. Properties may not produce the income expected, and debts may pile up.
This can significantly hurt one’s debt service coverage ratio.
This is why it’s important you accurately calculate your interest coverage ratio. The interest coverage ratio measures one’s ability to pay the interest on outstanding debt.
You can calculate this ratio by dividing the earnings before interest and taxes (EBIT) by interest expenses for a certain period. In other words, the formula is EBIT/Interest Expense.
You should have an interest coverage ratio of at least 1.5 to avoid loan default and further complications. Again, be sure to consult a reputable broker who can provide the sound advice and support you need to invest in your new property.
At The Mortgage Shop, our experienced team of mortgage brokers and DSCR loan specialists will guide you throughout the process, simplifying the steps to securing the perfect mortgage for you.
Consult our experts and we’ll help you find not only the best debt service coverage ratio loans, but also the best places to buy vacation rental property, to begin with.
Trust in a Premier DSCR Mortgage Broker
If you’re wondering what a good debt service coverage ratio is, you are not alone. There are many ways to improve your ratio to at least 1.25. You can boost your net operating income. You can take care of debts. You can also decrease the amount you borrow and the expenses required to operate the property.
All in all, there are many ways to strengthen your debt service coverage ratio, but not all are easy, and not all brokers and lenders will treat you fairly.
If you want to diversify your portfolio and capitalise on the robust and varied cash flows of short-term and vacation rentals, you deserve a broker you can trust.
Don’t fall short of your financial goals or suffer with traditional loans that are burdensome. Whether you’re a novice investor or a seasoned realty guru, you want the best mortgage broker around.
Contact the consummate professionals at The Mortgage Shop and discover what our top-notch DSCR loan program can do for you.