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The Debt Service Coverage Ratio, or DSCR, is how no-tax-return investment property lenders qualify borrowers for a loan. In essence, it is a comparison of the property’s monthly rental income versus monthly expenses. DSCR provides a basis for determining the maximum loan amount an investment property can withstand. The higher the DSCR, the bigger the mortgage the property qualifies for. In terms of no-tax-return investment property loans used to finance 1-4 unit residential investment properties (non-owner occupied), the monthly rents are compared to five (5) monthly expenses of the property, namely:
Together, these are often called the “PITIA.”
The loan principal is the total loan amount, plus any costs of the mortgage that have been financed. Loans that are paid down over a set period (called “amortizing” loans) include monthly payments towards the loan principal. Loans also often have an interest-only option meaning that each month payments are made towards interest only, and no portion of the principal loan balance is paid down over the life of the loan. Instead, a balloon payment in the amount of the principal loan balance is due at the end of the loan term for interest-only loans. For loans that do amortize (i.e., are paid down during the life of the loan), a mortgage calculator can be used to determine the monthly principal and interest payments, based on given loan size, interest rate, and amortization term.
The next portion of the debt component of the DSCR calculation consists of taxes, insurance, and HOA dues. These are fairly self-explanatory. Calculate the monthly taxes and insurance for a refinance (or estimated monthly taxes and insurance quote for purchase) and add in any HOA dues present. The total of monthly taxes, insurance, and HOA dues (if any), along with principal and interest payments, make up all debts included in the no-tax-return investment property loan DSCR equation. It’s that simple!
For example, assume an investment property is rented for $2,000/month. Assume also the property has the following monthly expenses. Principal & Interest
$1,500/mo In this example, the DSCR = $2,000 Monthly Rent / $1,500 Monthly PITIA = 1.33. No-tax-return investment property lenders generally want to see DSCR above 1.00, and sometimes offer better pricing if the DSCR is above 1.25-1.50.
No-tax-return investment property loans can be used for both purchases and refinances. For a purchase, they provide a great way to qualify for a purchase loan without tax returns, income or employment, or historical bank statements. For refinances, in addition to all these benefits, no-tax-return investment loans can be used to tap into a property’s equity and “cash out” the property. For example, if the equity in a property increases, a real estate investor can obtain a no-tax-return investment property loan that provides cash in hand to be used for any business purpose.
No-tax-return investment property loans are long-term solutions, generally with terms of 30 years. Like traditional mortgages, they can be fixed or adjustable. The minimum down payment on a no-tax-return investment property loan is usually 20% (or minimum of 20% equity for a refinance), some lenders require up to 25% or more depending on credit, DSCR, and other factors including a reserve requirement. Larger down payments do often allow for a better rate. Gift funds from close relatives are usually allowed to be applied towards the down payment, and sometimes also for payment reserves. Rates for no-tax-return investment property loans are generally higher than traditional loans (based on increased perceived risk to lenders), but all other typical loan fees are similar, such as origination points, broker and lender fees, appraisals, title, and escrow, etc.
Although personal income and debts are not considered for no-tax-return investment property loans, personal credit is considered in the loan approval process. However, this requirement is typically no more onerous than what is required of a hard money loan. Lenders want to see that a real estate investor is generally able to pay their bills in a timely fashion. In addition, having more than 1 or 2 mortgage late payments in the previous year can often require a loan approval exception, which can sometimes delay or impede the process.
No-tax-return investment property loans are a great way to avoid hard money with a viable long-term financing solution for real estate investors. The lessened documentation and underwriting requirements are similar to hard money loans, while rates and fees are more akin to traditional loans.
Whereas traditional mortgage lending requires tax returns during the loan approval process, no-tax-return investment property loans do not. With these loans, real estate investors are able to purchase or refinance a property with no employment required, no personal income considered, and no debt-to-income ratio developed.
The only cash flow that matters is the rents of the property being financed. That’s it. If the monthly rents sufficiently cover the monthly expenses—principal, interest, taxes, insurances, and HOA dues (PITIA)—i.e., if the property DSCRs (debt services), the property will qualify.