To succeed with DSCR financing, you must speak the language of the lender. This glossary covers the essential metrics and terms used in underwriting your deal. Understanding these definitions will help you structure better loan applications and analyze properties more accurately.
1. Core Metrics #
DSCR (Debt Service Coverage Ratio) #
Definition: The primary measure of a property’s ability to cover its own debt obligations with rental income.
Formula: DSCR = Net Operating Income (NOI) \ Total Annual Debt Service
Why it Matters: This is the “credit score” of your property. A DSCR > 1.0 means the property is profitable. Most lenders require a minimum of 1.15 to 1.25.
LTV (Loan-to-Value) #
Definition: The ratio of the loan amount to the appraised value of the property.
Formula: LTV = Loan Amount \ Appraised Value
Why it Matters: LTV determines your down payment and interest rate. Higher LTVs (e.g., 80%) are riskier for lenders and typically carry higher rates. DSCR loans often max out at 80% LTV for purchases and 75% LTV for refinances.
LTC (Loan-to-Cost) #
Definition: The ratio of the loan amount to the total cost of acquiring the project (Purchase Price + Renovation Costs).
Formula: LTC = Loan Amount \ Total Project Cost
Why it Matters: Crucial for the BRRRR strategy or heavy rehab projects. While lenders lend on value (LTV), investors track leverage based on actual cost (LTC) to measure true “skin in the game.”
2. Income & Expense Terms #
NOI (Net Operating Income) #
Definition: The annual income generated by an income-producing property after deducting all operating expenses but before deducting taxes and interest payments.
Formula: NOI = Gross Operating Income – Operating Expenses
Why it Matters: NOI is the numerator in the DSCR formula. Note: In DSCR lending, lenders often calculate a “simplified” NOI using just the Gross Rent minus taxes, insurance, and HOA (ignoring maintenance/vacancy estimates for the ratio, though this varies by lender).
PITI / PITIA #
Definition: An acronym for the components of a monthly mortgage payment:
- Principal: The portion paying down the loan balance.
- Interest: The cost of borrowing money.
- Taxes: Property taxes.
- Insurance: Hazard/Homeowners insurance.
- **(A)**ssociation Dues: HOA fees (if applicable). Why it Matters: This total figure represents your Total Debt Service. Your rental income must exceed this PITI(A) figure to have a passing DSCR.
GSI (Gross Scheduled Income) #
Definition: The maximum potential rental income a property can generate if 100% occupied at market rents. Why it Matters: This is the starting point for all calculations. Lenders determine this via a 1007 Rent Schedule (an appraisal form that estimates market rent).
3. Valuation & Profitability #
Cap Rate (Capitalization Rate) #
Definition: The rate of return on a real estate investment property based on the income that the property is expected to generate. It assumes the property is bought with all cash.
Formula: Cap Rate = Net Operating Income (NOI) \ Current Market Value
Why it Matters: It helps you compare the profitability of different properties irrespective of financing. A higher Cap Rate generally indicates a better return (or higher risk).
Debt Yield #
Definition: A risk metric used by lenders to determine how quickly they could recoup their money if they had to foreclose and take over the property today.
Formula: Debt Yield = Net Operating Income (NOI) \ Loan Amount
Why it Matters: While less common in residential DSCR, it is vital in commercial/multifamily lending. Lenders often look for a Debt Yield of 10% or higher.
4. Loan Structure Terms #
Cash-Out Refinance #
Definition: A mortgage refinancing transaction in which the new mortgage amount is greater than the existing mortgage amount, allowing the borrower to take the difference in cash. Why it Matters: This is the “Refinance” step in the BRRRR method. It allows investors to pull their initial capital back out of a stabilized property to buy the next one tax-free.
Prepayment Penalty (Prepay / PPP) #
Definition: A fee charged if you pay off the loan early (usually within the first 1-5 years). Common Structure: 5-4-3-2-1 (5% penalty in yr 1, 4% in yr 2, etc.). Why it Matters: DSCR loans almost always have a prepayment penalty. You can often “buy down” this penalty (e.g., reduce it to 3 years or 0 years) by paying a higher interest rate or points upfront.
Entity Vesting #
Definition: Holding the title of the property in the name of a business entity (like an LLC) rather than your personal name. Why it Matters: DSCR lenders prefer or require you to close in an LLC to separate the asset from your personal liability. This protects your personal assets from lawsuits related to the property, which is crucial for professional, multi-property investors. This separation is also what allows lenders to underwrite the property as a commercial, business-purpose loan, bypassing personal DTI limits.
