Debt service coverage ratio loans, otherwise known as DSCR loans, are a common borrowing option among short-term rental property owners. This is because DSCR loans are based on the cash flow of the rental investment property rather than the income of the borrower. Here we will explain this little-known investment property loan.
Understanding Debt Service Coverage Ratio (DSCR) Loans for Vacation Rentals
DSCR loans may be an unfamiliar option for many borrowers, and they’re certainly different from your typical mortgage.
What is a DSCR Loan?
Traditionally, if you wanted to take out a mortgage to buy a property, you’d need to provide proof of personal income. A DSCR loan is slightly different. A DSCR loan looks at the income of the property in comparison to its debt. The income-to-debt ratio is known as the DSCR ratio.
A DSCR ratio of above 1 indicates a healthy cash flow, which is what lenders look for in rental properties.
Why DSCR Loans Are Ideal for Vacation Rentals
The primary focus of a DSCR loan will be the property’s cash flow. If a borrower can show the property will generate income, they may be able to borrow funding. This makes DSCR loans suitable for vacation rentals since the whole goal of a vacation rental is to make money. Many of those opting for DSCR loans are those who own short-term rental properties and can show their net operating income.
Qualifying for DSCR Loans for Vacation Rentals in California
The basic requirements involve the DSCR ratio. In most cases, it must be over 1. A lender will likely not lend to anyone who is barely meeting costs – not a good sign in any real estate investment. They need to know there’s a bit of room just in case costs go up before offering the maximum loan amount.
Property-Specific Considerations
Like any other piece of real estate, the lender will also want to consider the vacation rental property itself. This may mean considering the location, amenities, and rental history of the property.
Borrower Qualifications
While a DSCR loan won’t consider the borrower as much as other types of investment property or real estate loans, the borrower will still need to be considered and meet the minimum credit score requirements. Most borrowers are expected to have a minimum credit score of 620, make a minimum down payment of at least 20%, have cash reserves available, and be able to show bank statements if applicable.
Benefits of DSCR Vacation Rentals California
This is where we start to explore the benefits of DSCR loans for a real estate investor. We’ll also cover the negatives.
No Personal Income Verification
Since the borrower is unlikely to need to verify their income, the process is much more streamlined. There’s no looking for tax returns or various pieces of paper to prove you can afford the loan like with conventional loans, a common point of frustration for real estate investors.
Higher Loan-to-Value (LTV) Ratios
Some lenders require little downpayment on a DSCR loan. While 20% is typical, like most mortgages, some lenders may require a far lower downpayment when a property seems to be a ‘safer’ bet.
Flexible Underwriting Guidelines
A vacation rental is unique, and that means the loan underwriting needs to be just as unique. This is one of the rare lending types that will consider short-term rental income. It is also one of the rare methods of borrowing that can consider all types of property.
Portfolio Expansion Opportunities
There’s no limit to the number of DSCR loans a person or real estate investor can obtain, assuming they can continue to meet the requirements. Many vacation rental owners leverage their rental income to get a DSCR loan, which could help finance additional investments.
Challenges and Considerations of DSCR Loans for Investment Property
There are a few downsides to DSCR loans, however.
Higher Interest Rates
DSCR loans are a much more flexible type of loan, but they are also considerably riskier for the lender. This means they will often have higher interest rates. In California, average DSCR interest rates tend to fall somewhere between the low 7s and mid 8s, higher than most other types of investment properties.
Limited Lender Options
The average bank is unlikely to offer DSCR loans. This means you’ll often need to spend a great deal of time hunting around for a quality company that offers vacation rental DSCR loans.
Managing Vacation Rental Operations
Remember, a DSCR loan is given on the understanding that you’re now running a vacation rental property, specifically short-term rentals. This means you need to run the property properly to keep the property’s income coming in so you can meet your loan obligations. This is a lot of work, and you’ll need to focus on things such as marketing, booking, cleanings, and property maintenance.
Finding the Right DSCR Lender for Your Vacation Rental in California
There aren’t many DSCR vacation rentals California lenders. However, there are some, and you need to spend time finding the right one for your needs.
Researching and Comparing Lenders
DSCR loans can cover all types of rentals and rental income. You need to find one that specializes in short-term vacation rentals. DSCR lenders who specialize in vacation rentals tend to understand the seasonality of these properties a bit more.
Working with a Mortgage Broker
Ideally, when you’re looking for a DSCR loan, you should work with a mortgage broker just as with more conventional loans. This makes the process much more streamlined.
Conclusion
If you wish to find out more about DSCR vacation rentals in California, or you’re considering applying for a California DSCR loan, contact District Lending today. They can help make your dream of owning a short-term rental property a reality.
Resources:
DSCR Calculator: https://www.omnicalculator.com/finance/dscr
