Lew Sichelman
For years, small-time investors could gain the same kind of favorable financing available to buyers who planned to live in their homes. Lately, though, many mom-and-pop tycoons are turning to different kinds of funding.
The same loans that make homeownership possible for millions of families are still available to these housing merchants. But the underwriting guidelines have been tightened considerably, making them far more difficult to come by, especially for people who own multiple properties. So, some investors are switching to DSCR loans, which stands for Debt Service Coverage Ratio.
The rate for a DSCR loan is somewhat higher than for conventional, owner-occupied financing. But the buyer can qualify based on the cash flow the underlying property is expected to generate – as opposed to their income and credit record.
“The property qualifies, not the borrower,” said Shawn Yerkes of Genstone Financial Services, a major lender in the sector.
The rules on conventional loans limit the number of mortgages one person can have. And they require proof of income and employment, copies of your tax returns and other documentation. DSCR loans, on the other hand, focus on whether the property can support enough rent to cover the proposed mortgage payment.
Better yet, said Yerkes, investors can have as many DSCR loans as they want. It all depends on how much money each house is expected to generate in the form of rent. The more it produces beyond the borrower’s debt, the better.
What DSCR Lenders Look At
Yes, lenders like Genstone still look at their borrowers’ credit reports, but “we don’t look at their personal information at all,” Yerkes said. Nor do they go through their entire credit histories.
What matters most is the ratio of the projected rent to PITIA: the combined payment for principal, interest, taxes, insurance and (homeowners) association dues.
The ratio is calculated by dividing the gross rent by the monthly PITIA expense. If the ratio is below 1.0, the property doesn’t generate enough money to pay for itself. At 1.0, the borrower is breaking even. But at 1.25 – the ratio most lenders like to see – the house is earning 25 percent more than is necessary to pay off the loan.
On a rare occasion, lenders might approve a loan in which the ratio dips to 0.9, Yerkes said. And some lenders may go even lower if you make a bigger down payment and pay a higher interest rate.
Here’s an example from AmeriSave Mortgage: Say you want to buy a $400,000 house you intend to rent. You put down 25 percent ($100,000). With a 30-year DSCR loan at 7 percent for the remaining $300,000, your monthly payment for PITIA would be $2,471 a month: $1,996 for principal and interest, $350 for property taxes, $125 for insurance and no HOA dues.
Now, say the property rents for $3,100 per month. (If the property is not yet occupied, lenders will want a professional rent analysis or a comparable rent schedule based on the property’s appraisal.) Divide that amount by your $2,471 monthly cost and you get a DSCR calculation of 1.25. If you could rent the place for more, the ratio would be even higher, making you an even better candidate for approval.
All kinds of properties are eligible: Single-family houses, condominium apartments and two- to four-unit properties all qualify. At National Mortgage Center, another DSCR lender, even buyers of short-term rentals can often be approved, and sometimes multifamily projects of more than five units make the grade.
Major Part of ‘Non-QM’ Lending
This kind of business-purpose lending has been available in the commercial sector for ages. But for the last few years, it has been creeping into the residential side. And now, it has become a major part of what’s known as non-QM lending – that is, non-qualified mortgages – which now is responsible for 11 percent of all mortgage originations.
Non-QM loans don’t meet the rigid standards set by Fannie Mae and Freddie Mac, the two government-sponsored enterprises that purchase mortgages on the secondary market, then bundle them into securities, which they sell to investors. Fannie’s and Freddie’s rules are cut-and-dried.
DSCR loans, on the other hand, are often purchased by long-play investors like insurance companies and private equity firms – outfits, said Yerkes, that “want to own the loans as assets.” But they come with rates that can be up to 2 points higher than regular residential mortgages.
Some other features borrowers need to understand: DSCR loans often come with three- to five-year prepayment penalties, and lenders may require as many as 12 months of cash reserves. They also want at least 20 percent down, and their clients need credit scores of at least 620.
Besides the basic ratio calculation, the property has to be appraised and the title has to be clear. You’ll also need a copy of the lease, but there’s no standard lease form required.
“It’s not overly complicated,” Yerkes said. “There’s no set of rules or documents. Underwriting is streamlined, and one lender may approve the loan when another lender rejects it. And the loan does not go on your record.”
Lew Sichelman has been covering real estate for more than 50 years. He is a regular contributor to numerous shelter magazines and housing and housing-finance industry publications. Readers can contact him at lsichelman@aol.com.
