Image by Alexander Stein from Pixabay
Alexander Stein from Pixabay

A Debt Service Cover Ratio (DSCR) loan allows you to leverage the earning potential of your property in order to qualify for a loan, making it an excellent way to get started with real estate investing if you have less-than-perfect credit. Typically, these loans are offered by private lenders, who can provide more unique mortgage products than strictly regulated banks and credit unions.

To calculate the DSCR, the lender will take a look at the property's rental history, then develop a ratio of its earnings versus the mortgage and other costs associated with renting the property. Generally, lenders are looking for a ratio of 1.2 or above, at which time you can begin to negotiate the terms of the loan. But what are the steps you must take to get DSCR loans? This article will outline the different aspects involved in attaining that all-important mortgage, from your initial investigation to closing the deal.

Step one: develop your investment goals

Before you begin looking at properties and shopping for a good lender, you need to have clear expectations of what you will be getting from your real estate investment. Of course, you want to make money, but what is the minimum return on investment that would satisfy you? How much are you willing to spend on renovations before you place the property up for rent: are you willing to do quite a bit of rehab, or do you expect the property to be nearly ready for market by the time you buy it? You also need to decide whether you're looking at storefronts, apartment complexes, or single-family rentals.

Step two: gather your financial documents and hunt for a DSCR lender

It's easier to talk to lenders if you already have all your financial documents prepared, as these will generally be the first things they will ask for before you start looking at specific properties. This information includes tax returns, bank statements, proof of income, and balance sheets, but be prepared to provide more should they ask. With this in hand, look for lenders who specialize in the type of property you want to purchase.

Step three: calculate the DSCR

To calculate the Debt Service Cover Ratio, you need to know the Net Operating Income (NOI); in other words, how much in pure profit you make from the property per year, minus operating expenses. You'll divide the NOI by the annual mortgage payment, otherwise known as the debt service. Lenders want to see a DSCR of 1.2 or more, though some may have higher requirements.

Step four: write a business plan

Many investors forget that when you're investing in physical property, you are running a business: it is nowhere near as hands-off as stocks or bonds. As such, you need a business plan which details your investment strategy, the property's profile and the projected return on investment, and how you will repay your loan. This doesn't just prove to lenders that you understand what you're doing, but it will also serve as a guideline for you as you move forward.

Step five: submit your loan application and negotiate the terms

When you submit your application to the lender, they will perform an assessment of your financial profile and the property's profile, with a greater emphasis on the property itself rather than your personal finances. They may perform an appraisal on the property or ask you for more documents, which is why it's a good idea to have them all available from the start.

When they've approved the loan, you can now negotiate for the best terms; this includes the interest rate, length of the loan, down payment amount, and amortization schedule. It's a good idea to get a real estate lawyer involved at this point so that they can ensure your best interests are represented throughout the process.

Step six: complete due diligence

Whenever you are buying a property, it's essential that you have a clear picture of the property and any issues that you need to resolve. You should get a home inspection from a qualified inspector, as well as have the deed and title checked over to make sure everything is legal.

Step seven: finalize the documentation and close the loan

Once you've determined that everything is to your liking, it's time to seal the deal. In this step, you'll get all the final documentation required for the loan, then set a time to close. The closing meeting will involve officially signing the loan, handing over the down payment and closing costs, and finally receiving proof that the loan is complete.

With this last step, you're officially a real estate investor and the proud owner of the property. Now you can begin looking for tenants or working with existing tenants, ready to pay back your loan and continue to grow your investment.

The DSCR loan process is typically faster than that for a conventional loan, but that doesn't mean it doesn't require diligence and hard work from you. However, by working with a great lender, you can get the keys to your first investment property sooner than you ever could have dreamed.