DSCR loan: The no-income-doc mortgage
DSCR loans can change the game for real estate investors.
Rather than tying your borrowing power to your past earnings, debt service coverage ratio (DSCR) loans look forward. DSCR loans rely on the future earnings of the new rental property to underwrite the loan.
This is a huge plus, allowing investment property buyers to keep their personal income out of the mortgage application process.
But these loans have their drawbacks, too. To find out whether this investment strategy would work for you, check out these DSCR loan pros and cons.Submit your DSCR loan scenario.
What’s in this article?
Let’s start with this loan type’s advantages. They include:
Since underwriters use future income from the rental property you’re buying, they won’t need to verify your personal income. This helps property buyers whose income is complex and hard to verify.
Full-time and just-starting real estate investors often don’t show much income on their personal tax returns. In fact, avoiding employment income taxes is one of the advantages of investing in real estate. But that makes getting a traditional mortgage harder. Agencies like Fannie Mae and Freddie Mac require 100% income verification. DSCR loans let you skip this requirement.
Your personal earnings don’t factor into the debt-service conversion ratio (DSCR) that measures loan eligibility, so lenders won’t need to contact your employer. This can speed up the borrowing process, especially for self-employed buyers.
When you buy rental property with a traditional mortgage, the new house payment has to fit within your monthly household budget. Financing rental homes that way could limit your ability to borrow for personal needs later.
DSCR loans could help keep your rental property separate from your personal finances. According to Chron.com, the loan might not show up on your personal credit report if you close in the name of the LLC. Most DSCR lenders allow you to close in the name of an LLC, something most traditional lenders don’t.
Financing is based on the property itself — and not on your personal finances. Each rental property supports its own financing. You could borrow for multiple properties simultaneously, building your portfolio of homes faster.
DSCR loans can close faster than traditional home mortgages. Lenders can move faster because they aren’t spending time analyzing your personal income and employment history. And, these loans are usually funded by private lenders who can make quick decisions and eliminate red tape.
DSCR loans are reviewed by real people, not computer systems. Decision-makers at these banks can approve a strong scenario even if it doesn’t fit into guidelines perfectly.Check your DSCR loan eligibility now.
Every financing strategy has some drawbacks. DSCR loan cons include:
DSCR loan-to-value ratios (LTV) top out at 75% to 80%. This means borrowers must come up with a down payment of 20% to 25% — a lot higher than the minimum for conventional mortgages, which allow a down payment as low as 15%.
If your new DSCR loan payment equals the rent you’re earning on the property, the loan has a DSCR of 1.0. Most lenders want to see DSCRs of 1.25 to 1.5, meaning rent from the property exceeds the loan’s payment by 25-50%.
If rents are low compared to property values in your market, you’ll have a lower DSCR which would jeopardize your eligibility.
Some lenders will offer 35-year or 40-year terms which lower each month’s loan payment, raising the DSCR. But longer loan terms charge more interest.
Interest rates on DSCR loans are higher than those of a traditional home loan. You may score a better rate by making a larger-than-required down payment — or if your debt service conversation ratio (DSCR) is 1.25 or higher.
It’s possible to get a primary residence loan with a credit score of 580 — or even lower in some cases using an FHA loan. DSCR lenders want to see higher scores. A FICO of 620 is a minimum; some lenders want to see scores of 640 or 660.
DSCR loans work best when you’re buying a property that already has a tenant paying monthly rent. You can still finance an empty rental, but the lender will have to analyze the local market to assess the property’s potential rental income. You’ll need the appraiser to work up a Fannie Mae Form 1007 market rent analysis to prove future income.
Lenders like to see a backup plan in case you lose the tenant whose rent payments, ultimately, are paying the mortgage. The best security cushion, from a lender’s point of view, is money in your bank account.
Some lenders will require you to have three to six months of payments in the bank so you can keep the loan current while recruiting a new tenant.
Property listing prices can exceed the capacity of a DSCR loan. Some lenders cap DSCR loans at $1 million or $2 million; a few may go as high as $5 million.
These caps should leave room to buy a single-family home or even a duplex, triplex, or fourplex in many markets. But buyers of large complexes may need a commercial real estate loan.
A DSCR is not a consumer product, so federal consumer protections — such as the ban on prepayment penalties — do not apply. Borrowers should read the terms of the loan closely before signing the documents.Apply for a DSCR loan.
Investors who want to build their portfolio of rental homes quickly like the speed and simplicity of DSCR loans.
And these loans are a powerful tool for beginning investors who don’t want their personal finances intertwined with their new business ventures.
But if you’re looking to make a small down payment and pay a low mortgage rate — or if you’re buying a huge, multi-unit complex — it’s best to keep shopping for another type of loan.
Yes. DSCR lenders base eligibility on the income your new rental property will earn. They won’t need to check your personal income or employment history.
Lenders will need information about the property you’re buying. They’ll order an appraisal and an appraiser’s market rent analysis, or the home’s current lease agreement, if there is one. You may also need to prove you have money in savings for a down payment and cash reserves. You’ll also need to consent to a credit check.
DSCR loans are good at what they do: giving real estate investors a way to borrow money without relying on their personal finances.
Some lenders specialize in DSCR loans, but most large mortgage lenders do not offer them. Search online or ask your financial advisor if you’re not sure where to start.
It’s a common scenario: Would-be investors putting off buying rental properties, thinking they can’t start investing until they pay off their primary residence, or until they get their student loans under control.
Meanwhile, the price of real estate continues to rise, making it even harder to get a foot in the door of the local rental home market. Time that could have been spent building for the future continues to slip away.
DSCR loans can turn the tables on this dilemma by leveraging your future earnings from the property you’re buying — instead of relying on your personal finances and last year’s income — to get the loan.
For a lot of investors, DSCR loans offer a way to get ahead.Submit your DSCR loan scenario.