Qualifying for Mortgages Based on Property Cash Flow

Many real estate investors in Canada and the United States face a common hurdle: qualifying for mortgages based on traditional income and debt-to-income ratios. However, alternative pathways allow investors to leverage the cash flow of their properties to secure financing. This article explores the concepts of the Debt Coverage Ratio (DCR) in Canada and the Debt Service Coverage Ratio (DSCR) in the US and how they can help investors expand their portfolios by focusing on property-based lending rather than relying solely on personal income. The information in this article comes from a podcast that aims to educate investors about different financing options in the US and Canada.

Traditional Lending vs. Property-Based Lending

Traditionally, lenders in both Canada and the US assess mortgage applications based on an individual’s income, existing debts, and the number of properties owned. This approach can limit investors who have strong cash-flowing properties but may not have a high personal income. However, some lenders offer programs that allow investors to qualify based on the rental income generated by the property itself. These programs utilize the DCR in Canada and the DSCR in the US.

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Understanding DCR and DSCR

Debt Coverage Ratio (DCR) and Debt Service Coverage Ratio (DSCR) are essentially the same concept, with the former used in Canada and the latter in the US. These ratios allow investors to qualify for a mortgage based on whether the property’s cash flow is sufficient to cover the mortgage payments. The loan can be approved if the property’s income covers the mortgage at a specific loan-to-value (LTV), even if the investor’s personal income does not meet traditional requirements. These loans are often considered “business purpose” loans in the US.

Key Differences Between Canada and the US

While DCR and DSCR serve the same purpose, there are important differences in how they are applied in Canada and the US:

• Stress Tests: In Canada, residential lenders apply a stress test, requiring borrowers to qualify at a rate that is 2% or more higher than their actual interest rate. This makes qualifying for mortgages more difficult. In the US, there is no such stress test.
• Loan-to-Value (LTV): In Canada, getting up to 80% LTV on a rental property purchase or refinance is generally more straightforward. In the US, LTVs usually go up to 75% on purchases and 65% on cash-out refinances. However, some US lenders may go to 75% on a refinance once US credit has been established.
• Interest-Only Mortgages: The US offers interest-only mortgages, which can be factored into the DSCR calculation, potentially allowing a property to qualify even if it doesn’t have positive cash flow. This is not typically an option in Canada.
• Mixed-Use Properties: In Canada, mixed-use properties are generally acceptable for DCR programs. In the US, mixed-use properties can be a challenge for DSCR programs, although there can be exceptions.
• Cash Flow Analysis: When calculating DCR, Canadian lenders may not use 100% of the rental income and may factor in expenses such as vacancy, property repairs, and property management. In the US, for the DSCR calculation, lenders may exclude these expenses and focus on property taxes, condo or homeowner association fees, and annual insurance.

How the Programs Work

The process generally begins with a potential investment property that an investor is considering. The lender needs the following information to run the numbers and determine if the property qualifies for a mortgage:

• Property Address: The specific location of the property is necessary.
• Rental Income: The property’s income is essential for the DCR/DSCR calculation.
• Property Taxes: This recurring expense must be factored into the cash flow analysis.
• Condo or Homeowners Association Fees: If the property has these fees, they must be included in the analysis.
• Annual Insurance: The cost of insuring the property must be considered.

Once this information is gathered, a cash flow analysis can be performed to see if the property meets the required ratio for financing.

Fees and Underwriting Styles

It’s important to note that commercial loans in Canada and DSCR loans in the US come with fees. These fees vary depending on the loan size, complexity, and how quickly the loan needs to close. Also, remember that commercial loans in Canada and DSCR loans in the US have different underwriting styles, and it is important to seek expert advice when navigating these differences.

Lending Caps and Strategies for Growth

In the US, lenders may have caps on the number of loans they will fund and may sell the debt, resulting in a change of lender for the investor. In Canada, caps are less common, and investors have options to partner with another lender if necessary. Once an investor is in the program, lending generally becomes unlimited as long as the properties continue to cash flow.

The Importance of Expert Advice

Many investors are unaware of these programs and may end up with private mortgages with higher rates and fees. It is important to seek expert advice to determine your investment goals’ best strategy and leverage the most beneficial financing options. The podcast suggests investors set up a strategy call with an expert to navigate these programs and analyze if they are a good fit.

Additional Considerations

• The podcast mentions foreign nationals investing in the US may have different LTV restrictions.
• The Burr method, which involves buying, updating, and refinancing a property, might not be as successful in the US due to lower LTVs on refinances.
• While it is generally more challenging, DCR programs in Canada can be used for single-family homes, although lenders typically prefer two-unit or larger properties.

Conclusion

Using DCR and DSCR programs can be a game-changer for real estate investors looking to expand their portfolios. By focusing on the cash flow of a property, investors can access financing that might otherwise be unavailable to them based on traditional lending criteria. Navigating these programs requires a good understanding of the differences between Canada and the US, and seeking expert advice can significantly improve an investor’s chances of success. The key is to get educated and explore these opportunities to become a more successful real estate investor.

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Frequently Asked Questions

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