Are you an investor thinking of buying a short or long-term rental property in Minnesota? The debt service coverage ratio (DSCR) loan might be your best loan option.
This is a great loan for real estate investors to secure funding based on property cash flow instead of their personal income.
With a DSCR loan, borrowers don’t have to worry about tax returns, pay stubs, W2s, or other income documentation.
What’s in this article?
The DSCR loan provides much-needed flexibility for investors and entrepreneurs who can’t qualify for a loan to invest in properties.
Investors can qualify for the DSCR loan faster because they have no stringent personal verification required. The primary factor the mortgage lender is concerned with is the subject property’s cash flow.
Some real estate investors might find it challenging to get a conventional loan due to write-offs and business deductions.
Tax returns and pay stubs are often unavailable to investors or do not accurately reflect their actual income.
Instead of using the investor’s income documentation, lenders compare the property’s income against the future mortgage debt payment.
A 1.25x DSCR is typically considered an eligible ratio, since it conveys that the property brings in 25% more income than its payment. However, some lenders require a DSCR anywhere from 1.0 to 1.5 and some don’t have a minimum at all.
DSCR is expressed in decimals like 1.25x or 1.11x. The “x” means the number of times the property’s net operating income (NOI) covers its debts.
Here’s how you calculate DSCR:
DSCR= Income / Debt Service
Example: An Airbnb with monthly income of $8,000 and a payment of $5,800 would have a DSCR of $8,000 / $5,800 = 1.45 (the income is 1.45x the monthly debt service).
If a property’s debt service coverage ratio is 1.45, it earns more than enough to meet its loan payments.
To reduce the possibility of a default or foreclosure, mortgage lenders prefer a project with a DSCR greater than 1.
Calculating income is important because it significantly impacts the debt service coverage ratio.
An inflated income will overstate the money available to service the debt.
For residential properties, the income is simply the monthly rental amount.
In commercial properties, it gets more complicated. Lenders use Net Operating Income, or NOI. To find NOI, subtract all necessary operating expenses such as maintenance, management, and utilities from a property’s income.
The DSCR payment is the future mortgage principal and interest payment, taxes, insurance, and HOA dues, if any. Contact a DSCR lender to determine your interest rate and payment.
Example: How higher rent can improve DSCR
Example: How lower payment can improve DSCR
Tip: To be more certain of your DSCR approval, see how you can increase a property’s income or reduce the payment.
Many DSCR lenders look at 1.25x as Minnesota’s minimum, although some allow 1.0 or even waive the minimum for otherwise strong scenarios.
Some lenders consider a DSCR from 1.0x-1.1x is unstable, as a short vacancy or a large repair project can derail the investor. Such lenders prefer a DSCR of at least 1.25.
Minnesota DSCR loan guidelines
Is it hard to qualify for a DSCR loan? No, it’s easier in some regards because there is no personal income verification required. Investors can skip providing complex tax returns and hours on the phone with their accountant to supply documentation needed for a conventional loan.
You only have to buy a property that will generate enough income to make your mortgage payment and turn a profit. Other requirements for DSCR loans include the following.
Loan-to-Value (LTV) Ratio: The maximum loan-to-value (LTV) ratio is 75-80%, meaning you’ll need a 20-25% down payment.
Loan purpose: The DSCR loan can be used to refinance or purchase a home, or to take cash out.
Minimum Credit Score: Similar to some traditional loans, the DSCR mortgage credit requirement is usually around 640.
Property types allowed: DSCR mortgages can be used for single-family residences, 2–4-unit properties, 5+ unit apartments, office complexes, hotels, resorts, etc.
Loan type: 30-year fixed, adjustable-rate, 40-year fixed with a 10-year interest-only period, and more…
Income and employment, debt-to-income ratio: Unlike traditional loans, DSCR loans are tied to your investment property income, so pay stubs or employment verification aren’t required and lenders don’t review your debt-to-income ratio
Maximum loan amount: The maximum mortgage amount varies from lender to lender but can be as high as $5 million.
Maximum properties owned: There’s no restriction on how many properties you can own or how many loans you can take out with DSCR loans.
Prepayment penalty: Unlike standard investment property mortgages, DSCR loans usually include a prepayment penalty.
Cash reserves: Typically, six months of the full payment, but up to 12 months for lower DSCRs.
Closing in the name of an LLC: Most DSCR loan lenders allow LLCs to close.
Seller-paid closing costs: Some lenders permit the seller to contribute funds toward your closing costs.
DSCR loan mortgage rates in Minnesota can be 1% to 2% higher than traditional loan rates such as FHA or VA loans, as they offer more flexibilities, like no income verification.
Property values are soaring throughout Minnesota’s lake country. In an analysis of residential properties in 11 counties between 2021 and 2022, they discovered values have increased by 25% to 30%. Some of the areas with the best history of appreciation in Minnesota include:
- Crow Wing
- Otter Tail
The highest bidder receives the title when a property is auctioned in Minnesota’s sheriff’s foreclosure auction. At the same time, the owner retains the right of redemption.
Therefore, “buying” the owner’s redemption rights is an investor tactic.
However, if there are junior mortgages, take caution since an investor who redeems in the owner’s place will be responsible for the second mortgage.
Research and understand the market you intend to invest in. Understand market trends, consumer behavior, and laws that relate to your prospective investment.
For example, most Minnesota cities require landlords to have a rental license to collect rent legally. Also, Minneapolis, landlords have to pay a one-time charge of $1,000. This is called a rental conversion fee, which is required when investors convert a single-family home to a rental.
Once you make an offer, sellers expect that you provide the financing details. This means you’ll need to know how you’ll finance the purchase and obtain a pre-approval before you submit any offers.
It is a common mistake for first-time investors to buy the first house they see. Buying a property is like shopping for shoes. You check different stores, try on different shoes, and get to know what a good value is. That’s the best way to get the right deal. Check out as many properties as possible, and don’t get emotionally attached to any.
Specialize in one area, and don’t try to do it all. It’s impossible to be a good investor, a good realtor, and a good property manager. All of these roles require different skills and experience. Hire the best hands and let them do their jobs.
Like traditional loans, submit your application and exclude any personal details such as tax returns, W2s, paystubs, etc.
The lender will pull your credit and review your assets and order the appraisal to evaluate and report the fair market rent.
This figure is then used to determine your debt service coverage ratio.
Yes, you can refinance a DSCR loan. Most DSCR loan lenders offer purchase loans as well as cash-out refinance options.
DSCR loans require an appraisal. A rental survey will be required if you need a loan to invest in a real estate property purchase. The rental survey will help the lender understand the expected rental income. Similarly, the lender might require an appraisal with a rental survey for a refinance.
Banks could approve your loan application easily with the right DSCR. A high DSCR means your investment property makes more money than it costs you, while a low DSCR indicates a business is not making enough to cover the mortgage payment.
Secure your investment with a DSCR loan
Minnesota is a fantastic market to invest in real estate, and a DSCR loan could make it happen.
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