My Perfect Mortgage
DSCR Loan Vs Conventional Wise Comparisons
7 minute read
March 24, 2023

DSCR loan vs conventional loan: Either one can finance a real estate investment, but one will probably outperform the other.

Your best choice will depend on your unique needs.

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Income documentation - Winner: DSCR

Maybe your personal income won’t support another conventional loan. Or maybe you have the income but can’t provide the right documents to prove it. In these cases, a DSCR loan is tailor-made for you.

DSCR lenders won’t ask for your tax returns, pay stubs, W2s, profit-and-loss statements, or other personal income sources.

They won’t ask for these documents because your personal or business income will not underwrite the loan. Instead, cash flow from the property you’re buying will secure a DSCR loan. 

If your new rental property will earn enough monthly income to cover the loan payment that’s due on the loan each month, a DSCR lender can approve the loan, assuming it meets the lender’s other requirements. That’s how DSCR loans — or debt-service coverage ratio loans — loans work.

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Down payment - Winner: toss-up

Conventional loans offer down payments as low as 3%, but only when you’re buying a home to live in. To buy an investment property with conventional financing, you’ll need to put at least 15% down. That’s $15,000 in cash for every $100,000 borrowed.

DSCR loan down payments need at least 15% down as well, but some lenders require 20% — or $20,000 per $100,000 borrowed. This gives conventional financing a slight edge, right?

Not always. A conventional with 15% down will also need private mortgage insurance payments for the first few years, inflating the loan’s monthly payment. DSCR loans don’t require PMI even with less than 20% down.

Depending on the size of your loan, PMI could add hundreds of dollars to the loan’s monthly payment. That money won’t go directly toward the real estate debt.

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Occupancy - Winner: Conventional

When you plan to live in the new property, a DSCR lender won’t finance it. DSCR loans depend on cash flow rental income for approval. So without rental income, there’s no loan.

Conventional financing offers more flexibility: You could buy an owner-occupied home, a second home, a vacation home, or an investment property — even though mortgage rates and upfront costs will vary a lot based on occupancy plans.

DSCR loans work for investment properties only.

Property cash flow requirement - Winner: Conventional

This one gets at the heart of the difference between DSCR loans vs conventional loans:

  • DSCR lenders: Need to know your new property will earn enough rental income to keep up loan payments
  • Conventional lenders: Need to know you will earn enough income to keep loan payments up to date

So, if your new property won’t earn rental income for a while, or if the rent won’t be enough to cover the mortgage payment, most DSCR lenders won’t approve your loan.

There are some exceptions here. Some DSCR lenders will accept lower cash flow if you compensate with a bigger down payment and show that you have healthy cash reserves in the bank to cover shortfalls.

But in most cases, you’re better off with a conventional investment property loan which qualifies based on your income and not on the property’s cash flow.

Even if you go with conventional financing, you could refinance into a DSCR loan later — when the property is generating adequate cash flow. Refinancing could free up conventional income eligibility for your next new property. 

Get approved for a conventional loan.

Mortgage rate - Winner: Conventional

DSCR loans are non-QM, meaning they’re not insured by a federal agency. Since lenders have less back up, they could lose more money if you default. To compensate, DSCR loans charge higher interest rates than conventional loans.

In fact, DSCR loan rates are about 1.5% to 2.5% higher than the rates lenders charge for a conventional loan.

But those conventional rates work only when financing a primary residence. DSCR rates are not much higher than conventional investment property rates.

Interest rates for new loans change every day. Learn more about today’s DSCR loan rates work here.

Credit score - Winner: DSCR

A quick Google search — or a chat with your favorite AI — says you can get a conventional loan with a credit score of 620. The same source will say DSCR loans usually require a score of 640.

They’re not wrong, but there is more nuance to consider. In reality, it’s harder for someone with borderline credit, in the 620 to 640 range, to get an affordable conventional loan. Lenders will often ask for a bigger down payment, and they’ll charge a higher interest rate, to balance out the lower credit score. 

In this scenario, you will probably have an easier time getting approved for a DSCR loan with lower credit since DSCR lenders can make exceptions and base most of the approval on property cash flow.

DSCR lenders usually consider each loan applicant on a case-by-case basis rather than using an algorithm to filter out applicants who don’t meet set rules. If the loan officer can see your scenario working, you have a good chance at approval. 

Conventional lenders need to sell your loan to outside investors, so they can’t make many exceptions to their rules. When they do make exceptions, they’ll likely need to justify them with higher rates.

Owning the property in an entity’s name - Winner: DSCR

Individual homeowners or Limited Liability Companies (LLCs) can close DSCR loans. Conventional loans work best when they close in the name of the individual borrower.

A lot of experienced property investors prefer doing business as LLCs, especially when they want to separate their business and personal finances and exposure to liability.

What about getting a conventional loan and then transferring the property into an LLC after closing on the loan? This doesn’t always work, and transferring the property without permission could prompt the lender to call the loan balance due in full.

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Property type - Winner: DSCR

Fannie Mae and Freddie Mac regulate conventional loans on behalf of the federal government. Conventional regulations help standardize lending and protect borrowers.

But these regulations also limit the flexibility of conventional loans. For example, conventional loans won’t finance all condos, only warrantable condos. Conventional loans won’t always finance a home you need to renovate, either.

DSCR lenders often grant exceptions for a non-warrantable condo or homes in need of repairs because lenders don’t have to follow as many rules.

Loan amount - Winner: DSCR

In most areas of the country, conventional loans for single-family properties max out at $726,200. Conventional loan limits are higher in places like San Francisco, New York City, and Seattle, where property prices are higher.

But even those higher loan limits won’t approach the DSCR maximum loan size of $5 million. Not all DSCR lenders offer loans this large, but it’s not hard to find one that does. A loan of that size can finance an apartment complex in some markets. 

Conventional loans that exceed annual loan limits become jumbo loans. Jumbo loans might require higher interest rates and a larger down payment. DSCR lenders won’t make a distinction between jumbo and conforming loan sizes.

Maximum properties owned - Winner: DSCR

Conventional loan rules limit borrowers to 10 active conventional loans at one time.

DSCR lenders don’t enforce this type of regulation. The cash flow from a property secures that property’s financing, so there’s no limit to how many properties you can have loans on at one time.

DSCR lenders measure cash flow through the debt-service coverage ratio itself.

  • A ratio of 1.0 means the property generates exactly enough rent to pay the mortgage payment
  • A ratio below 1.0 means rental income won’t cover the loan payment
  • A ratio above 1.0 means rental income exceeds the loan payment

For example, a property that earns $2,000 a month in rent but requires only $1,600 in debt would have a DSCR of 1.25. Its income exceeds its debt by 25%.

A lot of DSCR lenders like to see DSCRs in the 1.25 range, but some will go lower. Lenders can even approve DSCRs below 1.0 in some cases. To get approved with sub-1.0 DSCR, the borrower would need to document plenty of cash reserves and put down more than 20%.

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DSCR loan vs conventional loan: What’s your answer?

Conventional loans for investment properties will work well for a lot of real estate investors — especially those who want to leverage their personal income to break into real estate investing.

DSCR loans have the edge for investors who want to separate their business and personal finances. And for investors whose personal income won’t support another conventional loan, DSCR loans can be a game changer.

That’s one reason more experienced and first-time investors are turning to DSCR lenders for their rental property purchases.

See which loan type fits you best.

Our advise is based on experience in the mortgage industry and we are dedicated to helping you achieve your goal of owning a home. We may receive compensation from partner banks when you view mortgage rates listed on our website.