When real estate investors buy rental property, they count on earning rental income from the property. The new income then covers the cost of paying down the purchase loan.
But it’s difficult to initially secure traditional financing for the property when approval requires proof of income that you haven’t yet earned from a future rental.
This presents a unique challenge that requires tailored financing. For scenarios like this, a Debt Service Coverage Ratio (DSCR) loan can be secured based on the value of a property and the rental income it can earn, rather than your current income.
Connect with the perfect lender to explore your options and see what you qualify for.
Approval is based on measuring potential earning power of rental properties
Flexibility makes financing available and affordable for many scenarios
Higher loan limits and more eligible property types help build your portfolio
DSCR loans help full-time investors and self-employed rental home buyers who often can’t qualify using tax returns.
Essentially, a DSCR loan works for properties that earn enough rental income to cover their monthly mortgage payments. This is calculated using the Debt Service Coverage Ratio.
DSCR loans offer financing for short and long-term rental properties with higher loan limits.
Whether you’re financing a vacation home, a property you’ll rent to tenants full time, or multiple different properties, a DSCR loan applies to single-family homes and properties with 1-4 rental units.
You don’t need to provide standard proof of income to qualify for a DSCR loan. Instead you’ll find the best chance for approval if you have a credit score of 640 or higher, can make a down payment of 20-25%, and meet your lender’s DSCR requirement.
Some lenders require a DSCR of up to 1.5, which means the property would ear 150% of the home’s monthly mortgage payment.
DSCR loans allow flexible financing options for more complex or unique investment scenarios.
In comparison, standard loans don’t allow financing for properties with more than four rental units, and they may have restrictions for unique property types. DSCR allows for more unique scenarios as financing is based on rental cash flow, rather than meeting standard requirements.
DSCR lenders also don’t limit the total number of rental properties you finance, unlike traditional lenders.
DSCR loans can be given to an LLC, rather than an individual, which isn’t possible with standard mortgages. This can make it easier to keep your personal finances separate from your investment properties.
Calculating the Debt Service Coverage Ratio helps to estimate how much rental income an investment property can earn to show whether it’s a sound investment to finance.
To calculate the DSCR, divide the net operating income of the property by the total debt service. Net operating income is the revenue minus certain operating expenses. Debt service is the cash that is required to cover repaying interest and principal for a debt during a set period of time.
In other words, it’s calculated by dividing the potential rental income of a property by the mortgage payment for the property. This gives you a ratio that the lender will use as a benchmark to see whether the property can earn more than it costs to finance it.
A larger DSCR means there is more income to service the debt, making it more likely you’ll qualify for the financing you want.
DSCR requirements vary by lender and borrower. In most cases the DSCR needs to be 1.0 or higher because that means the rental income for the property can at least cover the expense of financing it.
If your DSCR is lower than 1.0 you may still qualify, but it might require a larger down payment or other supporting documentation, such as income verification.
As an example, if your rental income is estimated to be $2,000 a month and your mortgage payment is set to be $1,500 a month, dividing $2,000 by $1,500 shows a DSCR of 1.33.
This means the property would earn 33% more than its all-inclusive payment.
There are closing costs associated with processing any loan, and the costs of a DSCR loan are comparable to standard investment property mortgages. They include costs for the lender to service the loan, as well as an appraisal, and other fees.
You’ll also likely need to make a down payment that will be paid at closing. This is typically 20-25% of the loan amount. In some cases gift funds are accepted up to a certain amount to help cover these costs.
