DSCR: Debt Service Coverage Ratio in Relation to HUD 221(d)(4) Loans
When deciding whether to issue a loan to a borrower, one of the most important aspects a lender looks at is DSCR, or Debt Service Coverage Ratio. DSCR is a measurement of annual cash flow vs. annual debt obligations.
- What Is Debt Service Coverage Ratio (DSCR)?
- DSCR's Role in Multifamily Loans
- DSCR AND Loan-to-Value Ratio (LTV)
- To learn more about FHA 221(d)(4) loan options, fill out the form below and a HUD loan specialist will get in touch.
- OR, IF YOU'D LIKE INFORMATION RIGHT NOW, SIMPLY CONTACT US TODAY FOR A FREE CONSULTATION.
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What Is Debt Service Coverage Ratio (DSCR)?
When deciding whether to issue FHA multifamily construction loans to borrowers, one of the most important aspects a lender looks at is DSCR, or Debt Service Coverage Ratio. DSCR is a measurement of annual cash flow vs. annual debt obligations.
DSCR's Role in Multifamily Loans
The formula for calculating DSCR for HUD multifamily loans (and other multifamily and commercial loans) looks like this:
DSCR = Net Operating Income / Annual Debt Service
For example let's look at a multifamily property with an annual net operating income of $2,000,000 and annual debt of $1,500,000:
$2,000,000/$1,500,000= 1.33 DSCR
Considering the fact that most lenders prefer a DSCR of 1.20 or above, the example property would be well within the range of acceptability. The higher a property's DSCR, the lower the chance that the borrower will default on the loan due to unexpected expenses or other financial issues.
Keep in mind that a 1.0 DSCR is simply breaking even. So, it makes sense that FHA multifamily construction loan lenders would want some cushion between a property's annual income and debt obligations. However, the lower the DSCR requirement of the lender, the more money a developer can borrow (assuming the building's income and debt obligations stay the same.)
DSCR AND Loan-to-Value Ratio (LTV)
One thing that may allow a developer to get a multifamily loan with a lower DSCR is if the building's loan-to-value ratio (LTV) is lower.
LTV = Loan Amount / Total Value
In practice, that usually means that the developer either puts more cash into the project, or finds a deal in which they can purchase a multifamily property for less than the property's appraised value, therefore lowering the LTV of their potential loan. In turn, that can allow them to get away with a lower DSCR.
To learn more about FHA 221(d)(4) loan options, fill out the form below and a HUD loan specialist will get in touch.
OR, IF YOU'D LIKE INFORMATION RIGHT NOW, SIMPLY CONTACT US TODAY FOR A FREE CONSULTATION.
Related Questions
What is the debt service coverage ratio (DSCR) for HUD 221(d)(4) loans?
DSCR, or debt service coverage ratio, is a measurement of a property’s cash flow compared to the amount of money needed to pay current debts like interest, principal, and lease payments. For HUD 221(d)(4) loans, DSCR requirements are:
- 1.20x for market-rate properties
- 1.15x for affordable housing properties
- 1.11x for rental assistance properties
To learn more about HUD multifamily construction loans like the HUD 221(d)(4) loan, fill out the form below and a HUD lending expert will get in touch.
How does the DSCR affect HUD 221(d)(4) loan eligibility?
The HUD 221(d)(4) loan allows for some of the lowest debt service coverage ratios out there. The minimum DSCR allowable for a market-rate property is 1.18x, and it relaxes for affordable and subsidized properties, allowing for minimums of 1.15x and 1.11x, respectively. This means that HUD is willing to insure loans on assets that may appear slightly riskier. By comparison, Fannie Mae typically requires a more conservative DSCR of 1.25x, with Freddie Mac loans allowing for minimums of 1.20x depending on the market.
The DSCR is a key metric lenders use to assess the risk of default. If a debt coverage ratio is less than 1, that essentially means the property’s net operating income isn’t sufficient to cover the debt service. Therefore, the DSCR affects HUD 221(d)(4) loan eligibility by determining the risk of default.
What is the minimum DSCR required for HUD 221(d)(4) loans?
The minimum DSCR required for HUD 221(d)(4) loans depends on the type of property. For market rate properties, the minimum DSCR is 1.20x. For affordable housing properties, the minimum DSCR is 1.15x. For rental assistance properties, the minimum DSCR is 1.11x.
You can learn more about DSCR requirements for HUD 221(d)(4) loans here, and more about DSCR requirements for other loan types here.
What is the maximum DSCR allowed for HUD 221(d)(4) loans?
The maximum DSCR allowed for HUD 221(d)(4) loans is 1.20 for market rate properties, 1.15 for affordable housing properties, and 1.11 for rental assistance properties.
For more information, please refer to the following sources:
How is the DSCR calculated for HUD 221(d)(4) loans?
The DSCR for HUD 221(d)(4) loans is calculated by taking the net operating income of the property and dividing it by the total debt service. For market-rate properties, the DSCR must be at least 1.20, for affordable housing properties it must be at least 1.15, and for rental assistance properties it must be at least 1.11. You can use our DSCR calculator to help you calculate the DSCR for your property.
What are the implications of a low DSCR for HUD 221(d)(4) loans?
A low DSCR for HUD 221(d)(4) loans implies that the property's net operating income isn't sufficient to cover the debt service. HUD is willing to insure loans on assets that may appear slightly riskier by allowing for a lower DSCR than other financing options. For market-rate properties, the minimum DSCR allowable is 1.18x, while for affordable and subsidized properties, the minimums are 1.15x and 1.11x, respectively. By comparison, Fannie Mae typically requires a more conservative DSCR of 1.25x, with Freddie Mac loans allowing for minimums of 1.20x depending on the market. Source and Source.
- What Is Debt Service Coverage Ratio (DSCR)?
- DSCR's Role in Multifamily Loans
- DSCR AND Loan-to-Value Ratio (LTV)
- To learn more about FHA 221(d)(4) loan options, fill out the form below and a HUD loan specialist will get in touch.
- OR, IF YOU'D LIKE INFORMATION RIGHT NOW, SIMPLY CONTACT US TODAY FOR A FREE CONSULTATION.
- Related Questions
- Get Financing