DSCR Loans for Short Term Rentals

DSCR Loan for Short Term Rentals

DSCR loans for short term rentals are business purpose loans for real estate investors. They’re often used to finance rental properties that are rented for short term periods.

Potential Monthly Income

Rather than relying on the borrower’s personal income or credit history, DSCR loans focus on the property value and potential monthly cash flow it can produce.

Loan Eligibility

Loan eligibility is based on the vacation property’s ability to generate sufficient income to cover monthly mortgage payments.

DSCR Ratio

Private lenders calculate the DSCR ratio to see if the short term rental property is capable of generating enough revenue to support the monthly payments. A higher DSCR ratio indicates the property’s income can cover the debt.

Rental Portfolio Growth

DSCR loans give real estate investors the ability to finance multiple short term rental properties at once.

Vacation Rental Refinancing

As the rental property improves its cash flow, investors may refinance to reduce borrowing costs and increase potential returns.

Short Term Rental Loan Process

1. Borrower fills out a loan application with the property details, potential or current rental income and estimated credit score.
2. Lender requests borrower authorization forms to pull credit and order an appraisal.
3. Lender requests LLC documents such as Articles of Organization docs, Operating Agreement and EIN.
4. Lender calculates the potential monthly rental income. Taking into account the location, property type, local rental market rates and market demand trends.
5. The lender evaluates the property’s operating expenses, such as property taxes, insurance, property management fees (if any), maintenance costs, and utilities.
6. The lender calculates the Debt Service Coverage Ratio (DSCR) by dividing the property’s net operating income (NOI) by the total debt service (loan payment).
7. Many lenders look for a DSCR of at least 1.2, while others require a minimum 1.5 debt to income ratio. A higher DSCR ensures loan repayment, since the income is at least 20-50% higher than monthly debt payments.
8. If the short term rental meets the lender loan criteria, the loan is approved.
9. The title agency and funder work together to close the loan.
10. The borrower proceeds to purchase or refinance the rental property which can now be used as a short term rental on AirBNB or VRBO.

Tips for Short Term Rental Financing

1. Refinance personal debt and credit cards to increase your credit score before applying.
2. The minimum credit score to get approved is a 680. A good credit score is 720+.
3. Prepare all the necessary loan documents, such as Articles of Organization, Operating Agreement and EIN number.
4. Work with a loan broker who specializes in short term rental loans and can match you with multiple private lenders.
5. Find an insurance agent that is familiar with short term rentals.
6. Make sure you have enough funds for the down payment, prepaid interest, title insurance, title search fees, lender fees, etc.
7. Perform a local rental market analysis before applying for a loan.
8. Do not apply for an FHA loan if your income can’t cover both your primary residence and investment property.
9. Do not apply for an FHA loan if you have a bankruptcy, credit card delinquency or collection agency on your credit report.
10. Since traditional lenders run hard pulls on your credit report, running an unnecessary hard pull will lower your credit score.
11. Apply for a DSCR rental loan which is designed for real estate investors.

Conventional Loans for Short Term Rentals

In most cases, a conventional loan is used for a home mortgage on a primary residence. These are typically mortgage backed securities that are later resold on the secondary mortgage market.

Strict Qualification Requirements

Since traditional loans are later resold on the secondary market, they tend to come with strict loan requirements. This means providing 2 years of tax returns, 2 years of bank statements, primary home mortgage payments, etc.

Personal Income Requirement

Traditional banks will first sum up your monthly debt obligations. Such as your monthly credit card payments, primary residence mortgage payments, any home equity lines of credit, etc. Then, they will calculate if your income is sufficient enough to cover the additional monthly mortgage payment.

Good Credit Score

Mortgage lenders usually run a hard pull on your credit report. They will make sure you not only have a good credit score, but also no credit delinquency’s. DSCR loans do not run hard pulls.

Lower Interest Rates

Since they are guaranteed by the lender or a government-sponsored enterprise, such as Freddie Mac and Fannie Mae, they come with lower interest rate payments.

Lower Down Payment

When purchasing real estate, a 20% down payment is standard. However, traditional lenders allow you to purchase PMI insurance to put down 5% or even 10% at close.

Slow Approval Time Frame

Since these are “conforming” loans, they have to follow the minimum and maximum loan limits set by Freddie Mac and Fannie Mae. Therefore, slowing down the approval process through unnecessary paperwork.