What Documents Do You Need for a DSCR Loan?

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While still a relatively new product, DSCR loans continue to expand in use and popularity for investors looking to achieve financial freedom through real estate. Throughout 2023, we have published several articles about DSCR loans, letting the BiggerPockets community know how Interest rates and terms Designers, tender answers on repeatedly The questions asked About DSCR Loans and talk about exciting new product developments and expansions, including DSCR Loans from five to 10 units Multi-family properties.

This article will cover another big aspect of DSCR loans – specifically, what documents you will be expected to provide once you decide to take out a DSCR loan.

One of the more enticing aspects of DSCR loans to investors is the reduced documentation, paperwork, and general “hassle” when compared to traditional lending, including traditional options and banks. However, DSCR loans should not be considered “no document” loans – they are Do It includes a well-thought-out underwriting process and meaningful “common sense” documentation requirements, too. Sometimes people can be misled, thinking that they are loose origin mortgage loans akin to “Ninja(No income, no job, no assets) loans were popular in the early 2000s and helped cause the recent crash in the real estate sector.

After reading this guide, you should both be well-equipped to know what to expect in the DSCR loan underwriting process. And Being able to dispel any myths about DSCR loans being a repeat of the poorly documented “no document” loans of the past.

What are DSCR loans?

Although there is no agreed upon exact definition, here is a useful definition of this specific loan product:

DSCR loans are mortgage loans that are secured by ready-to-go residential real property, used strictly for business purposes and are insured primarily based on the property.

Important note: DSCR loans refer to the specific loan type, and the “DSCR” (Debt Service Coverage Ratio) is measurement These are used to underwrite and rate these loans (and other loans), but the scale and ratio itself are two different things than what are referred to as “DSCR loans.”

Some key things to note in the definition:

• DSCR loans are secured loans (meaning there is a security the lender can get if the borrower does not repay the debt). They are also mortgage loans, that is, secured loans for which the secured collateral is real estate.
• DSCR loans cover residential real estate, not commercial real estate. So investment properties that are commercial in nature (such as office buildings, retail centers, etc.) cannot use DSCR loans. These can be availed through commercial real estate loans that use the DSCR rating scale; However, these are not within the ‘DSCR Loan’ suite of products.
• DSCR loans are “for business purpose,” meaning only the owner of the property It is not possible to live in the property under any circumstances. These loans are only for investment properties where the property is owned and operated for business purposes and is leased for income. In addition, for DSCR loans whose purpose is “cash refinancing,” the use of cash withdrawal proceeds It must also be used for a commercial purpose. Generally, these proceeds are used for further real estate investment or costs related to the borrower’s real estate business and cannot be used strictly for personal uses, such as paying off personal credit cards or any non-commercial expenses.
• DSCR loans are “primarily property-based,” meaning the lender evaluates and qualifies the transaction Mostly but not completely Based on the investment potential of the property. This is a common misconception that people sometimes assume DSCR loans are purely on the basis of origin. DSCR lenders will run a personal credit (which, along with LTV and DSCR, is among The three biggest factors Determine your price and terms) They usually require three to six months of PITIA’s “reserves” in liquid assets. The rest of the documentation and underwriting will depend on the asset, but it is important to remember that qualification is not 100% dependent on the property. The importance of your credit and some basic liquid assets too.
• Finally, DSCR loans are for “ready” properties only, which means that any property that needs any major renovations or rehabilitation will not qualify, and you will likely need to explore hard money options instead.

DSCR Credits – Not “No Document” and Not “NINJA”

Loans with poor underwriting standards to ineligible borrowers was one of the generally agreed upon drivers of the real estate crash in 2008. It was common to see inexperienced borrowers qualifying for many loans and collecting them with almost no funds and strange loan structures. Furthermore, many of the eligibility criteria were low, requiring no proof of income or much in the way of assessing whether the borrower would be able to repay the loan.

For this reason, sometimes people hear about DSCR loans, which are notorious for being outstanding In the first class on origin and does not require or evaluate W2 or DTI income, and has been linked to poorly constructed loans in the past.

As the rest of this article will show, this is misleading, because DSCR lenders will require common sense documents to properly underwrite a file and assess and mitigate risk. Furthermore, DSCR loans are more conservative, for example, generally capping the value of long-term loans at no more than 80%, which requires Strict rules about third party ratings for ratingsand make a conservative assessment of how each property will perform as a rental.

In addition, DSCR loans generally do not contain any of the confusing and Filesadmin.coarre loan structures of the past, where borrowers experienced rapid and potentially rapid increases in interest rates. Almost all DSCR loans are 30-year fixed-rate mortgages, and those that aren’t usually fixed for at least five years have built-in limits against interest rates increasing too much, too quickly.

DSCR loan documentation requirements

Below is a brief checklist of documents that you will be expected to submit when proceeding with the process of obtaining a DSCR loan. It’s important to remember that DSCR lenders all follow exactly the same guidelines and requirements 100% as traditional lenders who originate Fannie Mae qualified loans.

DSCR lenders usually have the same guidelines, but each is a private lender and has differences. In addition, not all DSCR loans will have the exact same documentation requirements based on the same transaction and will not be applicable. Some examples of this are “entity” documents, which are only required if the loan is taken in the name of an entity, such as an LLC.

to request

The DSCR loan process typically begins with the application. Some DSCR lenders will use the standard Fannie Mae Model 1003 to request. However, this is designed for traditional loans (including regular owner-occupied loans) and includes a lot of questions and information that DSCR lenders don’t ask for.

Many DSCR lenders, especially those who focus solely on DSCR loans and financing for real estate investors, will have custom applications that contain only questions and areas specifically required to qualify for a DSCR loan. These specially designed applications are usually a few pages long and take about 15 minutes to complete.

Typical items included are questions about property, real estate investment experience, financial profile, entity (if borrowing through an LLC), and optional demographic information.

While all of this information will be checked and verified during the underwriting process, and approximations are generally good, it is very important to be honest with an application. As a DSCR lender, finding evidence of application errors later in the process can have serious consequences.

Credit authorization

This document authorizes the DSCR lender to draw a credit report for the guarantors of the loan. Note that mortgage lenders use a slightly different credit report with an emphasis on other real estate debt history than others, so your score with a DSCR lender may differ slightly from what you might find elsewhere.

Bank data

Generally, DSCR lenders will require two months’ worth of bank statements to prove minimum “reserves” of liquid assets, generally in the amount of three to six months’ worth of PITIA payments. While these loans should be used for business purposes, it is perfectly fine and acceptable for the individual borrower to pay the debt service out of personal funds if required. This can happen if the property is experiencing vacancy or turnover or perhaps it is a short term rental in a seasonal market, some months bringing in soft cash. Liquid asset reserves provide a “cushion” for these situations.

Most DSCR lenders will also allow retirement accounts or stock and bond portfolios to meet this requirement, often with a “cut” of 20% or so on the amount to account for lower liquidity and value risks.

Title insurance

DSCR lenders will require that the property be properly insured against possible damage and destruction, usually for a minimum loan amount or replacement cost. This ensures that if the property is destroyed, the DSCR lender can recover the money from the loan in a payment of no less than the principal balance. Flood insurance of this amount is also required if the property is located in a federally designated flood zone.

rentals

If the property is let as a long-term rental, copies of the leases must be provided, and they must be in proper order (clearly signed with rents and terms fully explained). There’s one thing to watch out for when buying a property that’s currently rented: Things run much more smoothly when the seller can supply those rents quickly.

Short term rental history

If the property is used as a short-term rental, the DSCR lender will usually require the last 12 months of reservations and receipts. Usually, they can be downloaded and sent fairly easily from short-term rental platforms like Airbnb and VRBO.

entity documents

These terms do not apply if you are borrowing as an individual but are required if you, like many investors, choose to form an LLC. For borrowers who go this route, some documents are usually required. It often depends on the state of incorporation.

Typical entity documents required by DSCR lenders include:

• Certificates of good conduct
• Configuration certificate
• Regulation materials
• operating agreement

renewal documents

For borrowers who follow the BRRRR method and use DSCR loans for quick cash refinancing, there is often a need to document all renovations. These will typically include receipts, invoices and work orders from rehab work on the property.

Conclusion

While there are a few documents that go into the loan file, they are obtained by the DSCR lender and do not need to be submitted by the borrower. They include appraisal, appraisal review and title insurance.

Overall, DSCR loans are a great product because the documentation requirements are limited and reasonable, ensuring solid underwriting and protecting against risk and market crash while not being a paperwork hassle and nightmare.

Note by BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.