DSCR vs. LTV: Understanding the Difference in Real Estate Financing

If you’re just starting to dig into the world of real estate investing, you’ve probably noticed the acronyms “DSCR” and “LTV” come up a lot in your research.

Debt service coverage ratio (DSCR) and loan-to-value ratio (LTV) are two key metrics in real estate financing that help to determine your mortgage terms.

What's in this article?

What is debt service coverage ratio (DSCR)?
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What is loan-to-value ratio (LTV)?
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How are DSCR and LTV connected?
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What are the key differences between DSCR and LTV in real estate?
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Which figure is more important?
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Apply today with Compass Mortgage
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In this article, we will break down DSCR and LTV, including how they work and what they mean in the context of your loan terms and investments.

What is debt service coverage ratio (DSCR)?

Lenders use DSCR to determine whether a property can generate enough income to cover its debt obligations.

Essentially, DSCR helps lenders evaluate the risk associated with loans and whether the property is able to support the mortgage payments.

DSCR is calculated using the following formula:

DSCR = Net Operating Income (NOI) / Total Debt Service

  • NOI represents the income generated by a property minus all operating expenses, including property management fees, maintenance costs, property taxes, insurance and other operating costs.
  • Total debt service refers to the total mortgage payments made on the property, including principal and interest.

What is considered a ‘good’ DSCR?

A DSCR of 1.0 means the NOI and debt are equal, while a DSCR of less than one indicates a negative cash flow.

Many lenders will accept a DSCR of at least 1.0, while others require a DSCR of at least 1.25.

A higher DSCR indicates a more favorable financial position for the property and can lead to more favorable loan terms, lower interest rates and larger loan amounts.

For example, an annual NOI of $500,000 and total debt service of $250,000 equals a DSCR of 2—which lenders would consider a strong figure.

Some lenders calculate DSCR annually, while others may consider the monthly income and expenses for a rental property.

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What is loan-to-value ratio (LTV)?

LTV in mortgage lending expresses the ratio of the loan amount to the appraised property value. Lenders use the LTV to assess the risk associated with a mortgage loan.

The LTV ratio is typically expressed as a percentage and is calculated using the following formula:

LTV Ratio = (Loan Amount ÷ Property Value) x 100

  • Loan amount is the amount you’ll borrow from a lender to purchase a property.
  • Property value can either be the appraised property value or the purchase price.

What is a strong LTV?

Let’s say the property you want to purchase is appraised at $350,000.

You plan to put down $70,000, which is 20% of the home’s value and are approved for a $280,000 mortgage loan.

($280,000 ÷ $350,000) x 100 = 80%

In this example, your LTV would equal 80%.

Most lenders are able to offer the most favorable terms to borrowers with an LTV of no more than 80%, including lower interest rates.

Borrowers can still get approved with a higher LTV, but they may have a higher interest rate.

In addition, borrowers may be required to purchase private mortgage insurance (PMI) if applying for a conventional loan or pay mortgage insurance premiums (MIP) if the loan is an FHA loan.

How are DSCR and LTV connected?

DSCR and LTV both assess the risk associated with a mortgage or real estate investment.

They don’t measure the same thing, but they provide complementary information to a lender about the risk.

High DSCR, low LTV

For example, in general, a high DSCR and low LTV indicate to a lender that the property will generate enough income to cover the debt (DSCR), and that the borrower has more equity in the property, which reduces the risk for the lender (LTV).

Low DSCR, high LTV

On the other hand, a low DSCR and high LTV indicate a higher risk for the lender because the property may not generate enough income and the lender has to finance a larger portion of the property’s value.

Of course, a borrower can also influence their DSCR and LTV to access more favorable terms, for instance, by raising rent or lowering expenses to improve DSCR or by making a larger down payment to improve their LTV.

What are the key differences between DSCR and LTV in real estate?

DSCR and LTV are focused on entirely different aspects of a property and its financing.

Lenders use DSCR to assess a property’s cash flow and ability to cover the debt. As a result, DSCR isn’t necessary for properties that are not generating income.

DSCR loans are crucial for real estate investors because they offer greater flexibility for those who may need help to qualify for a loan based on personal income alone.

Meanwhile, lenders calculate LTV for just about any loan, whether it is generating income or not. The purpose of LTV is to assess the borrower’s equity and the extent to which the property is financed through debt.

LTV also plays a key role in determining mortgage terms, including whether PMI (or MIP) is required.

Which figure is more important?

DSCR and LTV are both important figures, but their level of significance varies depending on the context of a loan.

DSCR is a crucial metric for income-generating properties such as rental properties, multi-family units and commercial real estate.

In fact, DSCR often is the primary metric used for these types of properties to measure their financial viability.

LTV is a key factor for residential mortgages and owner-occupied properties. Moreover, LTV has a definite effect on whether a borrower qualifies for a mortgage and whether they must pay for mortgage insurance.

Both figures are important for real estate investors. Remember this for best results with your properties: High DSCR, Low LTV.

Apply today with Compass Mortgage

DSCR and LTV can be confusing; but when you work with an experienced mortgage lender like Compass Mortgage, you’ll have an advocate and partner by your side at every step.

Compass Mortgage treats our borrowers like family. You are not another transaction; you are a relationship we build together.

For investment loans in particular, a strong working relationship is key to a smooth, quick, successful loan process and the prospect of many deals to come.

Apply now to provide us with basic details about the property you want to purchase, and we’ll connect with you to provide personalized information about your loan options.

If you’re just entering the world of real estate investing or want to learn more about our process, give us a call at (877) 677-0609 or fill out our contact form to speak with us directly.

We look forward to helping you navigate the exciting journey of real estate investing!

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