What is a DSCR loan?
A Debt Service Coverage Ratio (DSCR) loan allows you to buy an investment property based on its rental income, not your personal income.
What's in this article?
These loans open up doors for investors because they don’t have to go the traditional route of supplying two years’ tax returns or W2s and paystubs to buy an investment property.
Full-time investors may not have traditional income, or may not be able to show enough income on personal tax returns to qualify for a rental property mortgage.
A DSCR loan, also known as the investor cash flow mortgage program, removes that barrier and can fund a loan based on the property’s good cash flow potential.
DSCR loans explained
Every rental property has a debt service coverage ratio. DSCR is simply a comparison between income and payments. DSCR tells the lender whether the property’s monthly income
“covers” the debt service cost, more commonly known as the mortgage payment.
A rental property with $2,000 in monthly income and a $1,500 all-inclusive payment has good cash flow.
Why, then, do traditional lenders insist on the buyer qualifying with her or his personal income? The house pays for itself, and then some.
DSCR loans leverage this situation to let the property qualify on its own.
The above example has a DSCR of 1.33, which is pretty solid. Most DSCR lenders would issue a loan for this home even without verifying the buyer’s personal income.
Can you buy a rental with a DSCR loan? Chances are good if you find the right property.
How is DSCR calculated?
Most DSCR lenders want to see a DSCR of 1.25 or higher. A DSCR of 1.25 means the property brings in 25% more income than the PITI payment. However, some lenders will accept a DSCR of 1.0 or even lower.
Here’s how to calculate DSCR:
DSCR = Income / Payment
When you’re analyzing a deal, plug in the numbers to see if you might qualify for a DSCR loan.
Lenders will calculate residential and commercial properties differently. Generally, properties with 1-4 units are classified residential while 5+ unit properties are commercial.
DSCR income calculation
Residential: Pretty simple. It’s the proposed or actual rental income. If there’s no lease in place, you’ll need an appraiser to estimate potential income on a Fannie Mae form 1025, also called a Freddie Mac form 72.
Commercial: The lender will use Net Operating Income or NOI. This is the gross yearly income minus all expenses like management, upkeep, and repairs over the past 12 months.
DSCR payment calculation
Residential: Add up monthly principal, interest, taxes, insurance, HOA and other dues.
Commercial: All principal and interest payments. Items like taxes and insurance are already factored into the income calculation for commercial loans.
Most of this post will focus on residential DSCR loans.
In the following table, you can see how residential DSCR changes as the payment falls.
|Rental Income||PITI Payment||DSCR|
|$ 2,500||$ 2,100||1.19|
|$ 2,500||$ 2,000||1.25|
|$ 2,500||$ 1,900||1.32|
|$ 2,500||$ 1,800||1.39|
|$ 2,500||$ 1,700||1.47|
|$ 2,500||$ 1,600||1.56|
|$ 2,500||$ 1,500||1.67|
Likewise, DSCR improves as income rises.
|Rental Income||PITI Payment||DSCR|
|$ 2,000||$ 1,700||1.18|
|$ 2,100||$ 1,700||1.24|
|$ 2,200||$ 1,700||1.29|
|$ 2,300||$ 1,700||1.35|
|$ 2,400||$ 1,700||1.41|
|$ 2,500||$ 1,700||1.47|
|$ 2,600||$ 1,700||1.53|
What is the minimum DSCR to qualify?
Most lenders want to see a DSCR of 1.25 or more. However, some go down to 1.0 or do not have a minimum. It’s best to check with a few lenders on their guidelines.
If the property has a low DSCR, find ways to improve it, like put more money down, find a better interest rate, or check if the current rental income is below market and could be raised.
How to qualify for a DSCR loan
In many ways, qualifying for a DSCR loan is easier than for a traditional loan. Guidelines vary by lender, but here are common requirements.
Most DSCR lenders require 20-25% down, in other words, 75-80% maximum LTV
Minimums vary, but most lenders require 640 or higher. Some lenders allow a previous foreclosure or bankruptcy as long as it’s over three years old.
Property purchase or a standard or cash-out refinance.
Non-conventional properties are sometimes allowed, such as non-warrantable condos, 5+ unit, commercial, and more. More traditional properties such as single-family residences, duplexes, and 3-4 unit properties are also allowed.
The loan must be for an investment/rental property. Long and short-term rentals (Airbnb, Vrbo) are allowed depending on lender.
Most lenders offer fiixed rate loans, adjustable rate mortgages, and interest-only.
Income and employment, debt-to-income ratio
The income and employment of the buyer is typically not verified. Because the borrower’s income is not verified, there is no debt-to-income ratio requirement.
Maximum loan amount
Loan amounts can go into the millions depending on lender.
Maximum properties owned
Most DSCR lenders do not have a limit on the number of properties the borrower owns.
Check with the lender before applying because some DSCR loans come with prepay penalties, which can equal thousands of dollars if you pay the loan off, sell, or refinance within a few years.
Closing in the name of an LLC
Unlike traditional lending, most DSCR loans allow you to vest title in the name of the LLC at closing.
Seller paid closing costs
Some lenders allow you to receive financial help from the seller to pay for closing costs. As the market turns more in favor of buyers, you may have leverage to request seller concessions which will bring down your overall cash required to close.
DSCR mortgage rates
Mortgage rates for DSCR loans are typically about 1-2% higher than conventional, FHA, or VA loan rates. However, some lenders might offer significantly lower rates.
Higher rates should be expected, though, since investment property loans are more expensive in general. Lenders view non-owner-occupied loans as more risky, and issue higher rates to compensate.
And because income is not verified, the lender relies 100% on the property’s ability to generate income. They can’t count on you being able to make the payments from other income sources if the house doesn’t rent or it otherwise doesn’t produce income.
Asset-based loans. Borrowers with a lot of liquid assets can qualify with no income verification. The assets themselves are used to determine that the mortgage payment can be made for a certain amount of time even without income. These are also known as asset depletion mortgages.
Bank statement loans. For those who make an income that is hard to verify, there are bank statement loans. The lender requires you to show regular income on the past 12-24 months of bank statements in lieu of paystubs, W2s, or tax returns.
Interest-only loans. Only the interest payment is required each month, lowering the monthly payment and potentially increasing cash flow. You don’t pay down principal unless you want to.
DSCR loan pros and cons
- No personal income or employment verification required
- Investor-friendly terms
- Potentially higher loan amount versus traditional loans
- Available on long- and short-term rentals, commercial properties and more
- Down payment of 20-25% required
- Typically, no primary residences allowed
- Properties that don’t cash flow may not qualify
5 tips for real estate investors
1. Focus on cash-flowing properties
A property that generates more income than the payment is not only a general requirement for DSCR loans, it’s also a great business plan. Cash-flow adds to your reserves each month or generates personal income. A property that has negative cash flow requires personal savings or income to keep it afloat. Anyone can buy a property with negative cash flow. But great investors look for deals with high income potential and low monthly debt and maintenance costs.
2. Background check your tenants
Whether you’re talking residential or business tenants, thoroughly vet anyone who will be in your property. Low credit scores, past evictions, income that’s too low to support the rent, or just a bad gut feeling should deter you from putting a tenant in the property. There will always be more potential tenants, but the wrong tenant can cost you a lot of time and money.
3. Get professional legal and accounting help
You’re an investor, not a lawyer or CPA. If you try to be everything, you’ll fail at one or more important aspects of your business. It’s worth the money for professionals who have spent years gaining knowledge and experience. It will save you money in the long run.
4. Consider professional management
Some landlords enjoy self-managing their properties. You can sure save money that way. But with so many aspects of managing – repairs, legal compliance, rent collection – some might opt to have someone else handle it.
5. Stick to one geographic area
Most investors stick to one or two general geographic area. There are two main reasons. First, you get to know the market extremely well. Is that a good price for a 3 bed, 2 bath home in that neighborhood? You won’t know without looking at hundreds of homes in the vicinity. Second, you can use the same agent, plumber, electrician, etc. for all your properties, eliminating the work of finding new agents and tradespeople for every home.
In high-cash-flow areas, it might be extremely easy to reach an acceptable DSCR, even on a single-family residence. In high-value markets, it might be more difficult to qualify, since property rents typically aren’t high enough to cover payments. However, in any market, investors are find cash-flowing deals where a DSCR loan could work.
DSCR loans can be very good, especially if you are a full-time investor with no W2 income and/or a lot of write-offs on your tax returns. These loans are approved based on the property’s income, not on yours, and come with many other flexibilities that help you grow your real estate portfolio quickly.
Not typically. Primary residences don’t generate income, so there would be no income to approve. Some lenders might entertain a multi-unit property where you live in one unit, as long as the property still had adequate debt service coverage. Talking to lenders on this question would be a key step.
Yes, these loans are considered non-QM, meaning they do not need to adhere to rules that govern conventional and government loans. They don’t require income verification like most loan programs.
You can qualify for a DSCR loan if the property generates enough income to meet or exceed the all-inclusive payment by 1-1.25 times. You don’t have to verify income or employment for most DSCR loans, but you must have a credit score around 640 or above and no recent foreclosures or bankruptcies.
Yes, DSCR loans require a down payment of 20-25%.
DSCR loans can be residential or commercial properties, but certain lenders may only offer them on one or the other.
You can use a DSCR loan to buy an investment property, but you typically can’t use them to purchase a primary residence, since a home you live in generally doesn’t generate income. DSCR loans require enough income to cover the payment.
Is a DSCR loan right for you?
DSCR loans open up opportunities for the right kind of buyer. Investors in short- and long-term rentals and other income-producing properties can expand their portfolios much more quickly than with traditional loans.
*This post is not meant to be investment, legal, or tax advice. Consult a professional for personalized guidance.