As a small business owner, you understand the grind involved with financing your operations.
After all, you’ve had your forays into investing in building your business from the ground up. However, while you had one path to follow as a startup, multiple other paths are branching away for expansion and investment.
Perhaps you want to move from your home office into an official space. Maybe you’re expanding to open a sister location. It could be that you’re in the property management business. However you got interested in real estate investment, you should know one of the best financing options available: DSCR loans.
Understanding Debt Service Coverage Ratio
DSCR stands for debt service coverage ratio; this number measures your business’s ability to repay its debt obligations. A DSCR loan is a real estate investment loan that uses the DSCR, among other criteria, to evaluate your eligibility.
Your DSCR is calculated by dividing your business’s net operating income (NOI) by its Total Debt Service (TDS). NOI is the revenue your small business generates minus all operating expenses, while TDS is the total debt payments you must make in a given period. This can include principal and interest payments.
- DSCR = NOI/TDS
- NOI = Gross Revenue-Operating Expenses
- TDS = all debt payments required in _____ [month(s)/year]
A DSCR of 1.0 indicates that a business makes just enough income to cover its debt obligations, while a ratio of <1.0 means the company cannot cover its debts each period. Lenders are looking for a DSCR of >1.0, which indicates the business has remaining profit after paying its debts. Many lenders like a minimum of 1.25 as proof the business has a healthy cushion.
Tips for Improving Your DSCR
- Increase Revenue and Cash Flow: Implement strategies to increase sales and improve your market efforts.
- Reduce Expenses: Execute cost-cutting measures such as negotiating better prices with suppliers, reducing energy costs, and cutting unnecessary expenses.
- Pay Off Existing Debts: Prioritize high-interest debt first, which will have the most significant impact.
Eligibility Criteria for DSCR Loans
A DSCR of 1.25+ isn’t all you need to qualify for a DSCR loan. Here are other things lenders look for:
DSCR loans are secured by collateral, as mentioned above. So, you need sufficient collateral to secure the loan. The value of the collateral must be equal to or greater than the loan amount.
Lenders want a track record of successfully managing a business and generating revenue.
Both your personal and business credit score are important factors. Lenders want to see that you have a good credit history and a strong score. 680 is a good number, though some lenders may require a higher number to qualify for higher loan-to-value options.
Last but not least, lenders will consider the industry in which your business operates. Some industries come with higher risks, so lenders may be more hesitant. You may need to provide additional documentation or collateral to mitigate their concerns.
Before applying for a DSCR loan, check your preferred lender’s requirements and ensure you have all the necessary documentation. Getting approved for a loan is always daunting, but you can sail through the process if you are prepared.
The Benefits of a DSCR Loan
As a small business owner, DSCR loans are an attractive financing option to grow your business. They offer several benefits over other loans.
Lower Interest Rates
DSCR loans typically have lower interest rates than other business loans, such as unsecured loans. This is because DSCR loans are secured by collateral, such as real estate or equipment, reducing the lender’s risk. Lower interest rates equate to lower monthly payments, helping you manage your cash flow and reduce the debt burden.
Longer Repayment Terms
DSCR loans also offer longer repayment terms, which can be beneficial if you need to finance a large purchase or investment for your small business. Longer repayment terms also mean lower monthly payments, like lower interest rates.
Access to Larger Loan Amounts
Since the DSCR loan is secured by collateral, lenders are often willing to lend more significant amounts to small businesses than they would with unsecured loans. This can be particularly beneficial for small businesses financing large projects or investments requiring considerable capital.
Improved Credit Worthiness
Taking out a DSCR loan and making timely payments can improve your small business’ creditworthiness, making it easier to secure financing in the future. In addition, a strong DSCR ratio can also improve your chances of getting approved for other types of loans or lines of credit.
If you are still determining if a DSCR loan is right for you, consider seeking professional financial advice. Financial advisors can help you identify areas to increase revenue, reduce expenses, and optimize your cash flow to benefit your DSCR. They can also help you develop a plan to pay off your existing debt and guide you through finding a DSCR loan.
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