The Debt Service Coverage (DSC), which is also known as the Debt Service Coverage Ratio (DSCR), is the ratio of cash available to the borrowers for lease, principal and interest payments. Used as a benchmark by traditional real estate lenders, DSC measures an entity’s (corporation or person) ability to produce enough funds for the purpose of covering their loan payments within the promised time frame. The first thing that a bank asks is your DSC ratio when you apply to get bank finance on an income property. This means that you can easily obtain business finance on an income property from a bank if your DSC ratio is high.
Investors often find excellent investment opportunities on leased and even empty properties but these properties do have the DSCR that banks need. In such cases, investors tend to work with reputed hard money lenders who offer them an interest reserve for the purpose of overcoming DSCR requirements of the bank. Such type of financing opportunities is not found with the traditional finance lenders.
How does interest reserve work?
Suppose you make loan payments of $1800 per month and want to apply for a bank loan on an income property. In case your rental income from the property is less than or equal $1800, it is impossible for you to get your loan approved. You must get in touch with the bridge loan lenders who can provide you with interest reserve.
Let us assume that you have purchased a property that is only 50% leased. But, you want to apply for a bank loan because you don’t have sufficient debt service cover for getting your loan approved. In order to overcome DSC requirements, you contact a well-known lender who offers you a finance of $1,000, 000 towards your purchase. However, the lender puts $ 100,000 into an escrow account, in order to allow you the funds for making the monthly payments. The lender pays $10,000 from the account for 10 months, to make the required payments.
While the lender is busy making the monthly payments, the owner is looking for a tenant for leasing up the vacant space. In most cases, the income property gets 100% leased at the end of the 10 months and the borrower has sufficient income for making the loan repayments. Borrowers now have no need to withdraw from the interest reserve to make the monthly payments.
What are the benefits of using interest reserve?
You have to pay considerably less to purchase an empty or 50% leased property. Once the property is 100% leased due to the interest reserve, it’s worth considerably more and also qualifies for a traditional/conventional bank loan. When the property owner refinances the hard money loan with the bank, he gets a lower traditional bank rate. It is vital to understand that without working with a reputable and renowned hard money lender, the property owner would have found it extremely difficult to acquire the property in the first place and would have lost an excellent investment opportunity too.