Are you looking for a way to finance your Airbnb investment? Are you concerned that your W-2 income or credit score might stand in your way? Have you heard about DSCR loans but can’t find one or don’t understand how they differ from conventional loans?

If so, don’t miss Episode 28 of the Host Coach Airbnb Podcast, where Nithesh Dhanashan completely demystifies DSCR loans and explains why they are ideal for Airbnb investors!

Read on to understand how to find a DSCR loan that uses short-term rental comps for maximum value so you can get started or continue to scale your portfolio as and Airbnb investor.

Topics discussed in this episode:

• How a DSCR loan differs from a conventional loan
• What makes DSCR loans ideal for Airbnb investments
• How to find a DSCR loan that uses short-term rental profits in its calculations
• How to prepare for a quick & easy loan application
• Nithesh’s advice for Airbnb investors looking for financing options

Host Coach Airbnb Podcast Episode 28 Show Notes:

Nitesh, how did you get into the mortgage industry, specifically for investors?

When I was an undergrad, I started working in retail banking to put myself through school and every branch that I worked at had a mortgage loan officer. I got to know a couple of them pretty well and got to know the industry really well.

This was right in the middle of the mortgage meltdown of 2007/2008. And while a lot of people were getting out of the mortgage industry - selling their homes, foreclosures, and short sales. Wall street was buying up property. Hedge funds were investing in real estate. And interestingly enough, in the retail banking space, a lot of the loan applications we were seeing come in, were not for primary residents, but for investment properties and that got me really interested in the industry as a whole.

And then in 2011 I got laid off from retail banking, and I immediately made the switch over to mortgages. Investment financing it's a whole different ballgame.

Did you see that Investment mortgages were recession proof and oops proof?

Exactly. And that's what it was. You're picking up properties at a much lower cost

And that 2008 meltdown is really what brings us to what we're talking about today, which is investment loans for mortgages. Specifically the DSCR loans really were born out of that age and are now approximating for the individual, what was capable for the multifamily investor to do using cashflow.

What is a DSCR Loan and How Does It Work?

So could you dive in a little bit, explain what is a DSCR loan and how does it work and how is it different from other mortgage products?

DSCR, first of all, it stands for debt service coverage ratio. It's the ratio between the rent on a property to the actual mortgage payment on that property. Now, conventional loans are qualified based on the actual borrower's debt to income ratio. If you've purchased a primary residence or any other mortgage, you've probably heard DTI or debt to income. And that's the total expense that a borrower has on a monthly basis. So your primary home mortgage, the subject loan for the investment property that you're purchasing any other monthly expenses, you have installment loans, you know, car loans, credit cards. So you're looking at the total debt versus how much monthly income do they have?

With the DSCR loan, you're not looking at any of that debt. You're not looking at the borrower's income. You're solely focused on the subject property. Can the rent on that property support the mortgage on that?

That's liberating for a lot of people who have the smarts and have been waiting and saving but have other things happening in their life. This makes Airbnb investing much more accessible. So your W 2 income or your 1040 income tax income is not what's qualifying you for the loan.

Correct. We're not even looking at those documents. We're not looking at tax returns, no pay stubs, W-2s, none of that is required.

Why DSCR Loans are Ideal for Airbnb Investments

A lot of real estate agents don't show a lot of interest. Income, particularly in the first couple of years, right? They're reinvesting in their businesses. A lot of investors like ourselves re-invest back into our properties. So a DSCR loan is a way to use the cash flow from the property to qualify for the mortgage payment.

That's exactly right. A lot of people who take advantage of this program are exactly what you said. They're savvy investor, they're a lot of times self employed. We have a lot of agents where they have great earnings, but at the end of the day, the net income may not be enough to qualify for a traditional loan.

Do you see an increased demand and the doling out of DSCRs?

I absolutely do. I will say previously, the advantage because the other investment option for financing is conventional loans. The big difference previously was that there was a significant difference in the interest rate when you're looking at conventional loans versus DSCR loans.

DSCR Interest Rates

That changed a couple of years ago. Fannie Mae and Freddie Mac made a big change in their non-owner occupied financing. So they updated their LOPAs, which are loan level pricing adjustments. What they said was: anything that's non owner occupied, they're going to increase the cost of getting a loan on, which essentially meant for investment properties, the interest rates were now higher. So that advantage they had went away and you're looking at a DSCR loan with a very hassle free process, less documentation, and now you don't have that huge advantage of interest rates with conventional loans.

So you're saying that there was at one point a wide gap that might be in people's minds between a conventional loan and a DSCR loan and that gap has narrowed now?

The gap as narrowed significantly.

The interest rates are still a little higher. There's still a small advantage in conventional loans, as the rates are still a little bit better. But, at the end of the day, you're looking at cash flow. It's an investment property, right? If you're going with the DSCR alone, the cash flows there and the return on investment is there. Why not go with that?

DSCR Loans for Airbnb Investors

So do you think this rise in DSCR loan applications and processing has to do with Airbnb?

Airbnb definitely has played a significant part in it. Because as I said, it's the rent versus the mortgage payment. Right? You never saw higher-priced homes being purchased for investment purposes. Now we're seeing million dollar properties that are being purchased for short-term rentals with a conventional loan.

You're looking at long term rental, when you're qualifying the loan. You're seeing, okay, how much can this property earn over a 12 month period? Now, if you're looking at higher priced properties, majority of the times, you're not going to see rental income that's supporting that type of mortgage. However, with the newfound success with Airbnb, a lot of investors have changed how they look at rental income and they've started allowing short term rental income to be calculated into that calculation.

Now, with those higher priced homes, we're seeing comparisons in that neighborhood, of how much are short term rentals going for in that area, and we'll actually use those numbers to qualify the loan.

DSCR Loans Using Short Term Rental Comparables

It is amazing. I've actually done a DSCR loan or two myself. And in that process, the income comparables were coming from long term rental comparables in the area, which worked, but weren't great. They weren't anywhere near what our Airbnbs were making. So what you're saying is you're now seeing programs, and your firm offers programs, that are using either the existing Airbnb income - rent rolls or comparable short term rentals in the area to qualify for that income?

Correct. I'm glad you phrased it that way, because tou can use DSCR financing, whether it's for a purchase or for a refinance, and if you already have an existing property that you've had rented out, and it's on the short term rental market, then you have a rent roll, like you said, that we can use it when evaluating your loan.

that wasn't an option before for DSCR financing previously, we could only use long term rental comparisons. Now, however, we're seeing investors and banks allowing for short term rental comparisons or short term rental history to be used. So on a purchase, you can use comparisons from other Airbnb properties in the area, correct?

Yes, or if it's a property that's already rented on the Airbnb market, we can use the previous history on that particular property to qualify the loan.

That would have saved Culin days and weeks of his life in our last couple of loan applications! Is that based on a rule change or is that based on on firms becoming more comfortable with this market?

Why DSCR Loans Have Changed

What we've done is we see what the market is looking for. We've gone after the actual investors and banks that allow these types of aggressive financing. I want to say our firm probably has about eight different investors and banks that allow DSCR financing and allow short term rental comps to be utilized.

It's fairly new, it's definitely not something everybody offers and it's not something that's been in the market for a long period of time. It's just what we are seeing and what the the consumer is asking for. Fortunately, the investors and banks are going along with that and providing the programs needed to support that need.

That's how multifamily loans have worked forever, right? It's always been based on the income generating potential of the property.

Correct. The cash flow on that property. And that's essentially where DSCR loans are derived from, because it made sense.

Now, DSCR loans are not 100 percent financing. As any investment property, you have to put a minimum of 20% to 25% down when you're purchasing or refinancing. So that equity is there, which makes the bank comfortable. And you're also looking at the supporting rental comparisons to say, "Yes, this property can actually cash flow."

So the risk to the lender is not really there. They're covering themselves?

Correct, it's common sense underwriting at the end of the day.

How to Find a DSCR Loan

I like the concept of common sense underwriting. So DSCR Loans are sounding pretty magical and I'm guessing that anyone listening is wondering, "How do you find a firm that offers DSCR loans?"

The same way you would with any other type of financing you're looking for. Call around. Lenders will advertise the fact that they offer this program, but it's something that is fairly new. Not just DSCR loans, but especially the short term rental being utilized in the application process. Find out who's offering it and get quotes from them and see what best suits you and you investment situation.

I feel like when you know what you're looking for, it's easier to find a loan, right? That it's a real thing. Right. So we're arming people with the vocabulary and the knowledge to ask around for a DSCR loan.

How to Be Prepared When Applying for a DSCR Loan for your Airbnb

What information would a potential client coming to you really need to have in hand to be prepared to talk with you and for you to quote and speak intelligently about a potential loan?

Prequalification is essentially is what a lender would need. And for that, have your documents ready. This program doesn't look for income documentation. So the biggest item that's being reviewed is the documents, assets, how much funds do you have saved up? Do you have the down payment needed to make this purchase? Is your credit where you need to be?

So, you're going through the application process, but also have an idea in mind of what you were looking for as well. What's the price point that you're interested in? How much money are you willing to spend to purchase this property? And do you have a monthly payment?

Also, if you've narrowed down an actual area where you're interested in purchasing, that makes a huge difference because the lender can get an idea of the taxes in that area. Is it somewhere where you need flood insurance, things of that

I got kind of excited thinking, as an investor, if I come to you with an AirDNA report and say, "I'm looking at this market and here's the average daily rates and the occupancy, and here's a property that I'm looking at. And I've done some analysis, done some underwriting, and this is what I'm looking at as my expenses," that's going to show you as a prepared investor.

Absolutely. The more prepared you are, the better, because we know what you're looking for and we know how to tailor that program specific to your needs.

Drawbacks to DSCR Loans

That makes sense. So we've covered a lot of the pros of DSCR loans. Are there any cons or negatives to using a DSCR? Or are there occasions where a different loan type would be better for someone doing Airbnb investing?

As I said, if you're going for a conventional loan, you get a slightly better interest rate, which at the end of the day means better cash flow. Right? The other big advantage is that conventional financing for investment properties technically starts at 15% down, which is lower than where you find DSCR loans start.

DSCRs usually don't go below 20% down for financing. Honestly, we offer both conventional and DSCR loans, and I would say majority of the investment property financing we are doing are DSCRs. And, if the property is cash flowing - you're getting the ROI, then it's a property you should seriously consider purchasing.

So, if you don't already have three or four Airbnb investment properties, if you have none, or this is just a second home investment, there may be conventional programs available withslightly better down payment possibilities?

DSCR Loans Allow for Scaling Your Portfolio Past 10 Properties

Correct. And Culin, you brought up a great point. With conventional financing you're capped, whether it's Fannie Mae or Freddie Mac, you're capped at a maximum of 10 finance properties, whereas DSCR does not have a limit. You can have as many finance properties as you want.

Now, one bank may not hold multiple loans for you, but they don't have a limit in how many total finance properties you have, which really allows for scale. If you're trying to build your portfolio and you obviously want to tap into the equity of other properties to reinvest in new properties... it's a great way to take advantage of that equity.

Credit Scores Requirements for DSCR Loans

I want to circle back. You've mentioned credit scores. So credit always matters, right? But, I feel like there's a different view on credit scores and a conventional loan and a DSCR loan. Could you speak to that?

Conventional loans technically start at a 620. Nowadays, with the market the way it's been, Fannie and Freddie are tightening up their guidelines. It's been very difficult for lower credit scores to qualify without compensating factors.

Meaning if you have a lower credit score, they're looking for low debt to income ratios. Lenders are looking for high reserves, meaning assets that are left over after you've made the purchase. And, if you don't have those offsetting factors, then it becomes difficult to qualify.

Whereas with DSCR, what it allows you to do is even at a lower credit score, you can qualify, but they will have some outlying factors as in they may require a higher down payment. If you are at a 740 credit score, they may allow 20% down. If you're at a 640, you can still get financing, but they may require 25% down or 30% down, but the options are less score dependent in a DSCR loan. At the end of the day, the property's cash flow is the main thing that these programs are looking at.

I love that a loan is focused on the money made by the property that you're getting the loan for. That makes a lot of sense for me.

Loan Advice for First-Time Airbnb Investors

Do you have any advice for first time Airbnb investors who are looking for financing options?

Find out what's available to you, but get your financing lined up before you go out and start looking. You don't want to end up looking and finding the ideal investment opportunity and lose out because you don't have the financing lined up. We see a lot of that. We have someone come in, they found a property, and they want to get a pre approval done right away. Now they're taking time to get the documentation together, completing the application, and by the time everything gets completed, that property is already off the market. And right now we're dealing with lack of inventory in a lot of markets. So, get your financing lined up before you shop!

I know every situation is different, but approximately how long is the pre approval process with your firm?

Pre approval is very quick. Once you get the documentation and the application over to us, it's essentially within 24 hours because we're looking at credit. We're looking at assets. And, if you have past experience investing, it's not required, but it helps. We're looking at all of those things.
Thank you for joining us. I think this has been extremely valuable. How can our listeners get in touch with you? They have more questions.

Please email me at neithesh@fdmhome.com.

I wish we had met you earlier in our investing career, but I think that we will be doing a lot of business with you and I hope that our listeners will as well.

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