As your business grows, it’s only natural to think about expanding it. Of course, to branch out your business ventures you will need a lot of finances to back you up. Even though your business generates a lot of profit, it’s always a better idea to consider a loan if you can obtain one instead of using out-of-pocket funds.
After the pandemic, we can safely say that commercial loan interest rates have gone up exponentially, but that doesn’t mean that you are all out of options. If the debt service coverage ratio (DSCR) is high for the property you have set an eye on, you might be able to obtain all the required fundings you need. Still, where there are advantages there are some disadvantages.
Below we expand on the topic of DSCR and how it can play an important role in obtaining loans.
How does DSCR work exactly?
The complete amount of a business’s cash flow and its debt obligations form the DSCR. This ratio can be used by borrowers to ensure lenders that all loan obligations will be repaid timely. However, different lenders will target different DSCR metrics including your company’s history, prior relationship with lenders, product pipeline, and more.
The DSCR formula requires net operating income and the entity’s total debt servicing. The net operating income is your company’s revenue minus COE (certain operating expenses) which do not include interest payments and taxes.
Lenders usually frown upon low DSCR and will probably refrain from giving you a loan if the business or property is below their set minimum which is usually 1.2. To calculate whether you can apply for a DSCR loan for that subject property, you need to conduct a thorough calculation. A debt service coverage ratio calculation can be performed by taking the property’s annual net operating income and dividing it by total debt obligations.
If your DSCR is around 1.2, then it’s highly likely that you will receive the loan required to invest in your business or for other business ventures.
For whom are DSCR loans the best?
DSCR loans are perfect for investors that want to keep their personal asset information private and not provide the loaner with payslips, tax information, and so on. This type of loan is also perfect for investors that want to use the funds to buy and hold real estate property.
The pros of DSCR loans
The main advantage of DSCR loans is that the investor will not have to provide any type of employment verification, annual income, disclose leases, or any other kind of information in order to obtain the loan. All the borrower is interested in is the subject property cash flow and its debt obligation.
Furthermore, you can commit to multiple properties at the same time. Certain loans will require you to commit to only one property and you won’t be able to get a second loan until you pay off the first one. With DSCR loans, you can make multiple investments as you can take out multiple loans at once.
Lastly, closing down deals with DSCR loans is much faster than with regular commercial loans. Usually, commercial loan lenders will go over all your documentation and conduct thorough background checks, which are quite time-consuming tasks.
The cons of DSCR loans
There are a few limitations that come with DSCR-based loans. For instance, if you need more funds, to be specific more than $5,000,000, a DSCR loan might not be the best option for you.
In addition, the down payment of DSCR loans can range from 20% to 25%, and on top of that, you can expect to pay anywhere from 0.5% to 1% of the total DSCR loan amount in fees. It is also considered a more complex formula when compared to other financial ratios, and it doesn’t have consistent requirements from one lender to another one.
Final thoughts
Knowing how DSCR loans work can help you assess whether your company can use the income to meet its principal obligations. To see whether you can qualify for a DSCR loan, take the generated revenue of the subject property and divide it with its debt obligation. The best part about DSCR loans is that you can commit to multiple properties simultaneously and your personal income is not taken into account.