EP.18 - Do Not Get a DSCR Loan Until You Know This

DSCR loans have quickly become one of the most powerful financing tools for real estate investors and self-employed borrowers, but they also come with hidden traps that can cost you tens of thousands of dollars if you don’t understand how they work.

In this episode of the SEI Mortgage Podcast, Ryan Marks breaks down the real pros and cons of DSCR loans so you know exactly when this investment property loan strategy works—and when it doesn’t.

If you are building a rental portfolio, buying investment property, or struggling to qualify for traditional mortgages because of tax write-offs, this episode will show you how DSCR loans allow investors to qualify using property cash flow instead of personal income or tax returns.

Key Moments in This Episode

00:00 – The truth about DSCR loans most investors miss
 01:02 – What a DSCR loan actually is
 02:15 – Why traditional mortgages fail self-employed investors
 04:10 – How DSCR loans use rental income instead of tax returns
 05:20 – Why DSCR loans don’t affect your personal debt-to-income ratio
 06:30 – The unlimited rental property advantage
 07:35 – Buying investment properties in an LLC
 08:50 – Can you buy your first rental property with a DSCR loan?
 09:45 – How investors buy rental properties with as little as 10% down
 11:05 – The hidden fees in DSCR loans
 12:15 – Why DSCR interest rates are slightly higher
 13:10 – Prepayment penalties explained
 15:10 – How to calculate if a prepayment penalty makes sense
 17:20 – The biggest DSCR mistakes investors make
 18:20 – How smart investors structure DSCR loans correctly

Use our free DSCR calculator (no email required):
https://seimortgage.com/dscr-calculator/

Explore more tools, resources, and non-QM mortgage strategies for real estate investors and self-employed borrowers at:

🌐 https://seimortgage.com

DISCLAIMER - Ryan Marks is a Licensed Mortgage Loan Originator (NMLS #519138) operating under The Turkey Foundation, Inc. (NMLS #236669), an Equal Housing Lender. Ryan conducts mortgage origination under his DBA, The Everyday Lending Group. SEI Mortgage is an educational brand only. It is not a mortgage lender, does not issue pre-approvals or loan estimates, and does not extend credit in any form. All information provided in this podcast is for educational and informational purposes only. Nothing in this episode should be interpreted as: Legal advice Financial advice Tax advice Real estate advice A commitment to lend An offer, quote, or guarantee of loan terms Loan guidelines, program availability, rates, underwriting rules, and qualification methods. This podcast is not affiliated with, endorsed by, or acting on behalf of Fannie Mae, Freddie Mac, FHA, VA, HUD, or any government agency. No government agency has reviewed or approved the content of this recording. The Turkey Foundation, Inc. 1805 E Garry Ave, Santa Ana, CA 92705 Equal Housing Lender

Transcript

SPEAKER_00 0:00

What if I told you there's a loan where your income doesn't matter, your credit stays clean, and you can own an unlimited amount of properties? But most people gloss over the traps buried inside that can cost you tens of thousands of dollars. The investors that win using DSCR loans aren't the ones moving fastest. By the end of this video, you'll know exactly what a DSCR loan is, when to use it, and when to avoid it so it doesn't bleed you dry. If that debt ratio is at one or greater, you essentially have a loan. It's that simple. Now that you know what it is and why investors are obsessed with the DSCR loan, let's go over some of the pros and cons of this loan product. Number one, there is absolutely no income documentation required on this loan product. Frankly, you could have no job whatsoever. Your property is the job to qualify. Sounds too good to be true? Well, frankly, more often than not, it is. But in this case, it is 100% true. Most conventional loans keep investors from scaling their portfolio because they utilize a debt-to-income ratio where the bank has to take the amount of your taxable income, including any other additional expenses. Now that you know what it is, let's get into why investors are obsessed with this DSCR loan product and what pitfalls to avoid so you can ensure that you scale your portfolio for years to come. Imagine walking in a bank and you make great income or you're running a profitable business, but maybe you show little to no income on your tax returns. So you're likely going to hear the loan officer unfortunately tell you, sorry, this seems like a great property, but unfortunately you don't qualify. Here's why. The property that you're looking to purchase is your income. Frankly, you could have no job whatsoever and still qualify for a DSCR loan as long as that loan debt coverages. So, what does debt coverage mean? Essentially, it is your mortgage payment, including all taxes and insurance, divided by what your proposed gross rent is. 100% of the rent is used, which will in turn give you a debt coverage ratio. Typically, the investor is going to want to have a one or higher debt ratio. However, there are plenty of loan products available that have no ratio, frankly, which we have covered in previous videos. So feel free to check those out. Number two, the DSCR loan often does not report on your credit. So why is that so powerful? Because every time you finance your next investment property using conventional financing, you're slowly bleeding into your debt-to-income ratio. So let's say you've built up your real estate portfolio, it's generating massive positive cash flow. You walk into the bank to go get qualified for that beautiful dream home that you've always wanted, but the loan officer says, sorry, your debt-to-income ratio is too high. You write off all this investment income on your tax returns. And although they may be profitable to you on paper, they look like they're doing poorly. The DSCR loan, we work with multiple DSCR investors where this loan never reports on your personal credit, in turn, never adding to your DTI, so you can qualify for that dream home down the road. In addition to conventional debt-to-income ratios, there is a limit of 10 on Fannie Freddy. So that means after you've purchased those 10 rental properties, you're cut off. Where pro number three, the DSCR loan, currently has no limit on the amount of loans that you can utilize to build your real estate portfolio. The number is essentially unlimited. So if you're thinking about this, you have a multitude of properties over 10 not reporting on your credit, not affecting your debt-to-income when you're looking to purchase that next primary residence, or maybe you're looking to take out another type of loan where debt-to-income ratios are used, and that fantastic portfolio that you've built is isolated within the DSCR loan. Number four, you can purchase these properties in an LLC or corporation. Frankly, the investor welcomes it. So what does that mean for you? Well, essentially, it's further protecting your portfolio, where in addition to it not reporting on your credit, it is not shown as an individual asset. One of the biggest fears when getting into building a real estate portfolio is what if someone tries to sue me? Heaven forbid that someone has an accident in one of the properties that you own and you are potentially liable for that. Well, having those properties in different LLCs only isolates you or exposes you for that matter to what assets are in within that LLC. Now, I am not a licensed CPA, so you'd want to seek out professional guidance to verify and how to properly set up your corporations. However, the investor welcomes the opportunity for you to place the property in an LLC or a corporation. And number five, here's a big one. If you are brand new to building your real estate portfolio and maybe you don't currently own a primary residence, guess what? You can still purchase your first investment property utilizing a DSCR loan with no prior investment experience and you don't need to own a current primary residence. We'll simply do a verification of rent just to show that you've made those payments on time. You can start building your rental portfolio while you work to earn that additional income to buy your dream home. Now let's get into the last pro of the DSCR loan products: low down payment. You can currently purchase a rental property using a DSCR loan with now as low as 10% down payment. You heard me correct. You can purchase a rental property as low as 10% down payment if the property debt coverages. So that means you're gonna have to find a strong asset that's going to positive cash flow right out of the gates. However, that is a massive decrease in the minimum down payment required when using a conventional loan, which is 20% on a single unit home. So that means if you're purchasing a single family, a condo, or a town home, you are required to put a minimum of a 20% down payment regardless of what sort of income this property is going to potentially make. And if you're purchasing a two to four unit, it is a minimum of a 25% down payment. Now that we've gone over a numerous amount of pros using a DSCR loan, we have to get into the cons. Number one being the fees. Fees on a DSCR loan are typically higher than conventional financing and often come with points. So what that means is because we need to make sure that the property debt coverage is the interest rate on your property, is a big determining factor on how much your property is going to debt coverage versus not. So when you're utilizing a DSCR loan, aside from which investor that you're using, that interest rate may come with origination or points needed to buy the interest rate down, and your standard closing costs could be slightly higher than what it would be using typical conventional financing, all the way down to the processing, underwriting, and standard third-party fees associated. Number two, the interest rates are slightly higher on the DSCR loan. Good news though is with where the market is currently, these DSCR rates are mirroring very close to conventional financing in the investor space. For example, if you're putting the standard 20% down payment required when using a conventional loan on a DSCR loan and you utilize a prepayment penalty, you are on average right at par with what the current conventional investment rate is, or maybe an eighth of a percent over, which is huge. And in previous videos, we have covered the pros and cons of when to utilize a prepayment penalty, but it just goes to show that the DSCR loan is continually closing the gap on interest rates, giving you the advantages of what traditional conventional financing would be. Which takes us into the last potential con of a DSCR loan is prepayment penalties. There's many loan products out there that don't require any prepayment penalty, but again, you have to remember if you're not utilizing a prepayment penalty, likely your interest rate's higher. And when I mean higher, that on average is 1% or greater over the standard conventional interest rate currently being offered at that time. So, how do you take advantage of all of this without getting yourself into pitfalls? Here's a couple things to keep in mind. If you are going to utilize a prepayment penalty, just make sure that you calculate the cost of recoup associated with using a prepayment penalty versus avoiding a prepayment penalty. For example, if you have one interest rate at 7% with no prepayment penalty and one interest rate at 6% with a five-year prepayment penalty, what's the difference in monthly payment? And what is the difference in cost associated between that monthly payment? You would take that monthly payment savings divided by the difference in cost associated, and that would give you the amount of months it would take for you to break even on utilizing a prepayment penalty versus not. Or secondly, if you're purchasing properties in states where the average purchase price is two, three hundred thousand dollars, guess what? The closing costs associated when refinancing a loan are typically the same, up to around a million dollars in finance loan. So that means when you're paying for title, processing, underwriting, escrow, notary, all those standard one-time third-party fees associated when buying or refinancing a home are going to exist whenever you refinance the loan. So if it costs you on average$4,500 to$5,000 in closing costs, if you're not paying any points and there's no origination on the loan, and should interest rates drop and you take advantage of those lower rates, how long would it take you to recoup those closing costs versus simply adding a prepayment penalty to bridge the gap while you further wait for interest rates to decrease? So let's unpack that just a little bit further because it is a lot to digest. For example, if you close your home now on a 6% interest rate with a five-year prepayment penalty, but the average interest rate was seven percent. And let's say a year goes by and now the current interest rates are at six percent, which you're currently at, you would have had to pay five thousand dollars on average for your closing costs to leave your seven percent interest rate you took at the time in order to go into the new interest rates at six percent. How much of a payment savings would that be if your loan amount was say two hundred thousand dollars, may only be a hundred or a hundred and twenty-five dollars a month in payment savings, but it took you five thousand dollars in fees in order to get that new six percent rate. You would have to take that five thousand divided by those average$125 in monthly payment savings, and that's how many months it would have taken you to recoup those costs versus just utilizing that prepayment penalty up front. So this is why the DSCR loan can be so powerful if it's used correctly. And it's extremely important that you talk to your loan officer and make sure that they're understanding what your overall vision is for building your real estate portfolio. Don't let your loan officer be an order taker and simply provide you with interest rates. If they are very good at what they do, they're going to look at what your one, two, five, and ten-year goals are, how you want to build your portfolio so that way you can structure your DSCR loans or your investment properties the correct way up front to avoid getting burned down the road. And this is why the DSCR loan is one of the best tools for investors to use if your eyes are open. So remember, if you're gonna scale past your conventional loan limits, protect your assets in an LLC, qualify using cash flow, don't use them as shortcuts to skip doing the math on your next deal. The investors that win using DSCR loans aren't the ones moving fastest. Hopefully, this episode gave you a quick snapshot on all the top level pros and cons of a DSCR loan. And if you're looking for other tools and resources on these great products and other numerous products available within this space, feel free to head over to SCIMortgage.com where you can also get in contact with us. I'd welcome the opportunity to discuss building your portfolio for you and how we can be a resource. And thank you so much for being a part of the community. Until next time, let your income work smarter, not harder. We'll see ya.