Short-term leases are an excellent way to achieve superior cash flow for the savvy real estate investor. However, one of the main challenges investors face is financing acquisitions. Typically, they target conventional loans, but using all STR rental income to qualify can be a challenge for Fannie Mae or Freddie Mac. These are the GSEs that purchase conventional loans and therefore develop underwriting guidelines. some investors choose to use HELOCS or Hard Money, but these products have very high rates and fees and can significantly reduce the additional cash flow benefits of STR investments.
There is a better way to finance this property type. This is a little known mortgage product that exists in the market today called a Debt Service Coverage Ratio (DSCR) loan. This is a portfolio product offered by non-principal investors. Portfolio loans are loans that are held by the lender and not sold on the secondary market. These loans can be more flexible and can be a good option for short-term rental properties because they are not subject to the same guidelines as conventional or government-backed loans. You will need to work with a true mortgage broker who can shop the secondary market for you, as banks, credit unions and mortgage banks do not typically offer this product.
DSCR is a financial indicator used by lenders to determine a borrower’s ability to repay a loan, expressed as a ratio. the DSCR ratio is calculated by dividing the property’s net operating income (NOI) by the total debt service (loan payments). Simply put, it measures the cash flow of the property after loan repayments. For example, if the property’s NOI is $100,000 and the total loan payments are $75,000, the DSCR would be 1.33 (100,000 / 75,000). This means that for every $1 paid on the loan, the property generates $1.33 in income.
A DSCR of 1.0 or higher will provide you with the best terms, offering you the lowest interest rate and the lowest down payment requirement. DSCRs below 1.0 can also be financed, and there are even 0.0 or no DSCR loan options, but it is expected that the down payment will need to be larger and the interest rate will be higher to get these flexibilities. Credit scores are also a major factor in determining these terms.
For DSCR loans, the property, not the individual, is eligible for the loan. This means there is no personal income eligibility and traditional documents such as W2s and pay stubs are not required. If you are refinancing and need to document rental income from the property for previous years, you may need to provide a tax return. The property must be non-owner occupied and can be a short-term rental or long-term investment property. Another great benefit is that you can close in the name of a corporation or entity (such as a trust).
Short-term rentals are a great way to buy a second home that you can enjoy while renting it out to cover the cost of ownership when you are not using it. In some cases, extreme cash flow can be achieved, making this a very profitable strategy for savvy investors. a DSCR loan solves one of the more common problems investors encounter in qualifying to finance a purchase or refinance an existing property, including cash-out transactions.
Want to learn more about this product and whether it’s right for your scenario? Clinton Sistrunk of the Colorado Mortgage Team is an experienced professional who offers these services nationwide. You can contact him at [email protected] to schedule a one-on-one strategy session. He will work with you to gain insight into the true capabilities of this product and ensure that you fully understand the benefits and risks associated with this loan so that you can make an informed decision about whether this product is right for your next investment.
