DSCR loans are designed to make it easier for real estate investors to qualify for loans. They’re typically 30-year fixed-rate loans that don’t require personal income documentation. Instead, they use the property’s income as collateral. This makes them valuable tools for real estate investors who are looking to grow their rental property portfolio. If you’ve ever considered getting a DSCR loan, you’re not alone – they’re an increasingly popular option for lenders and borrowers alike. In 2022, DSCR loans made up roughly 50% of non-QM transactions (or a little over 100,000 total loans, in just that year alone).
In this article, we’ll explore the pros and cons of DSCR loans so that, if you’re interested in applying for a DSCR loan, you can make an informed decision.
Understanding DSCR Loans
Before diving into the pros and cons of DSCR loans, let’s take a quick look at the basics. In this section, we’ll cover what DSCR loans are, how they work, who should consider getting one, and what’s required to qualify.
What Are DSCR Loans?
DSCR loans are financing options for real estate investors that prioritize the property’s income potential over the borrower’s traditional income verification (W-2s, pay stubs, tax returns, letter of employment, etc). This means the loan is approved based on the property’s ability to generate enough rent to cover the loan payments, making them attractive to new investors or those with personal income that doesn’t match most lenders’ strict requirements (like freelancers and the self-employed, who may have utilized extensive tax write-offs).
Since DSCR loans don’t use traditional income documents to verify income, they’re considered non-QM loans (non-qualified mortgages). Simply put, DSCR loans aren’t subject to the strict lending requirements set by the Consumer Financial Protection Bureau (CFPB).
In contrast to conventional loans where only a narrow demographic can qualify, non-QM loans tend to come in many different forms to accommodate non-traditional borrowers.
How Do DSCR Loans Work?
DSCR stands for “Debt-Service Coverage Ratio,” which takes the net operating income of a property and divides it by the total debt coverage. In other words: DSCR is calculated by dividing the property’s net operating income (NOI) by the total debt service (including interest and principal payments).
DSCRs that are lower than 1.0 indicate that the property isn’t generating enough income to cover its expenses, whereas DSCRs that are 1.0 or more indicate the property can “pay for itself.” The higher this number is, the better since the property can pay for itself, while still leaving the investor with a profit.
The DSCR metric is one of the main factors that’s used in determining qualification, which means borrowers can qualify for more properties without having to provide information on their personal incomes.
Who Should Get a DSCR Loan?
DSCR loans are great for new investors since they might not yet have a long enough income history to qualify for more rental properties. If you’re just starting out, it can feel almost impossible to save enough money through a W-2 job to buy a rental property.
Additionally, seasoned real estate investors are other good candidates for DSCR loans. Lenders tend to look at pay stubs and tax returns in order to get a good idea of your ability to repay a loan. Seasoned real estate investors are usually self-employed and don’t have those, so they need to turn their attention to non-traditional lenders who can verify their income through bank statements and other means like DSCR.
DSCR Loan Requirements
Since a DSCR loan is a non-QM loan, there’s no standard qualification requirements across the entire industry – each lender can set their own requirements. To determine exact qualification requirements, it’s recommended to reach out to lenders directly.
While we can’t speak for other lenders and their DSCR requirements, this is what we require at Defy:
- Minimum FICO score of 620+
- Maximum LTV of 85%
- Minimum DSCR ratio of 0.75
- 3 months cash reserve
- No maximum loan amount
- No income documents or tax returns
- Interest-only options available
Pros of DSCR Loans
DSCR loans can be a helpful tool for both new and experienced real estate investors. Next, we’ll cover the DSCR loan benefits.
Qualify Using Your Rental Property’s Income
Traditional mortgage loans use the house as collateral. DSCR loans are backed up by both 1) the property and 2) the property’s income. This makes it a safer option for mortgage lenders, so they don’t need to rely on personal income, just the property’s income.
LLC Ownership
Property can be purchased under an LLC, which can be used as an asset protection strategy.
No Tax Returns Required
DSCR loans may require less documentation compared to traditional loans. Traditional lenders look at tax returns, pay stubs, and more. DSCR loans can simplify the application process, but consult with a lender for specific requirements.
Quickly Build Your Real Estate Portfolio
Perhaps the biggest pro for real estate investors: DSCR loans allow you to quickly build a real estate empire. There’s no hard limit on how many properties you can purchase using DSCR loans. If you’ve always dreamed of managing a portfolio of rental properties, DSCR loans can allow you to do that without having to wait years before you can qualify for the next property.
Available for Beginner and Experienced Real Estate Investors
DSCR loans are available to a wide range of investors – both novice and experienced real estate investors can reap the DSCR loan benefits. For those just starting their journey in real estate investing, DSCR loans make it easy to qualify for that first property to build your portfolio. As long as it’s projected to generate income or has a solid income history, you have a chance at qualifying for a loan.
Faster Closing Process
Time is of the essence in real estate transactions. Typically, the average amount of time that a house sits on the market is about ~60-90 days. In 2024, however, houses sit on the market just 47 days before going under contract (and most investors will tell you that the best properties are under contract in just a few days). You need to get your financing sorted out if you want to compete.
DSCR loans frequently have a streamlined approval process, allowing you to close deals swiftly and secure investment opportunities before they disappear.
Options for Foreign Nationals
Geographical limitations don’t need to get in the way of your U.S. real estate investing dreams. DSCR loan options are often available to foreign investors, granting them access to opportunities in the U.S. real estate market. At Defy, our DSCR loans are available to foreign nationals, but not every lender offers it. When shopping around for lenders, it’s important to ask them if they offer DSCR loans for foreigners if you’re not a U.S. citizen or permanent resident.
Potential for Higher Loan Amounts
DSCR loans, based on a property’s strong cash flow, may grant you access to higher loan amounts compared to traditional financing options. Since qualifying for a DSCR loan isn’t tied to your personal income, you won’t have your income limiting the loan amount. This means that if a property is bringing in a lot of money per month, borrowers can qualify for a lot more financing.
Cons of DSCR Loans
Despite the great DSCR loan benefits, there are also some drawbacks to DSCR loans. To help you make an informed decision, in this section, we’ll be focusing on the cons to consider when getting a DSCR loan.
Limited Availability
DSCR loans are not as widely available as traditional mortgages. They are typically offered by specialized lenders and may not be available in all areas. This can limit your options when searching for financing. Lucky for you, however, Defy covers a number of states (and we’re quickly expanding). If you’re interested in applying for a DSCR loan, schedule a call with us and we’ll let you know what your options are.
Potentially Higher Down Payment Requirements
Qualifying for a DSCR loan often requires a larger down payment compared to traditional loans, but not always. This can range from 10% to 30% or more, depending on the lender and property. Generally, the down payment requirement ranges between 10% to 30% of the property’s purchase price.
Risk of Vacancy Periods & Market Volatility
DSCR loans rely heavily on the property’s rental income to cover the loan payment. If you experience vacancy periods or a downturn in the rental market, your ability to make payments could be compromised. Some factors to consider before getting a DSCR loan are vacancy rates and market trends.
Non-Standardized
DSCR loans are not subject to the same regulations as traditional mortgages. This means loan terms, interest rates, and fees can vary significantly between lenders. It’s crucial to carefully compare different loan options and understand all the terms before committing.
Tips for Applying for a DSCR Loan
DSCR loans can be a powerful tool for real estate investors, but navigating the application process requires some preparation. Here are some tips to increase your chances of success:
1. Know Your Numbers:
- Strong Rental Income: The cornerstone of a DSCR loan is a property with a demonstrably high and reliable rental income. Research rental rates in your target area and choose a property with a strong track record of occupancy. This will make it easier to qualify for a loan.
- Total Debt Service: In order to get an idea of how much income you’ll need to cover the monthly payments, you’ll have to calculate the total debt service. Check out our mortgage calculator to do the math on your property’s potential DSCR.
- Improve Credit Score: If you don’t have a strong credit score and haven’t started trying to improve it yet, it may be time to take steps toward it. Each lender sets their own minimum credit score requirements for DSCR loans, but having a higher credit score can help you secure better loan terms, which could include lower down payment requirements and lower interest rates. At Defy, we require a minimum credit score of 620 or above in order to qualify for our DSCR loans.
2. Prepare Your Documentation:
- Identity Verification Documents: Before providing you with a loan, most lenders will need to verify your identity for security purposes. Make sure to have documents such as your driver’s license or passport and Social Security Number (SSN) handy.
- Rental Income Verification: Gather documentation to verify the property’s rental income history, such as lease agreements and rent receipts.
3. Partner With an Experienced Lender
DSCR loans can be more complex than traditional mortgages. Find a lender specializing in DSCR loans, like Defy, who can guide you through the process, understand local market trends, and connect you with suitable loan options. Often, this expertise goes beyond just paperwork.
An experienced DSCR lender will be able to analyze rental trends and vacancy rates, so they can confidently support your projected income and expenses, and they can help you get pre-approved for a DSCR loan. Additionally, they can offer a range of DSCR loan terms tailored to your specific investment goals and financial situation. This personalized approach will help you find your perfect loan fit to secure the financing you need to bring your investment vision to life.
4. Be Transparent About Your Investment Goals
Being transparent about your investment goals with the lender is key to building trust and strengthening your DSCR loan application. Don’t shy away from clearly communicating your long-term plans for the property.
Are you looking for steady cash flow, aiming for property appreciation, or maybe a combination of both? Explain how the rental income generated by the property aligns with these goals. The lender is looking for a borrower who understands the market and possesses a clear vision for the property’s future and this transparency demonstrates a well-thought-out strategy. Ultimately, transparency becomes a valuable tool in creating a stronger DSCR loan application.
5. Get Pre-Approved
Getting pre-approved for a DSCR loan offers a significant advantage when securing investment property financing. It shows sellers you’re a serious buyer with the financial backing to close the deal. This pre-approval clarifies your borrowing power, allowing you to focus on properties within your budget and act quickly when the right opportunity comes around.
On top of that, lenders take pre-approved borrowers more seriously, streamlining the application process and potentially expediting loan approval. So, getting pre-approved gives you a head start in a competitive market and increases your chances of securing the DSCR loan you need.
6. Find the Perfect Property
Finding the perfect property can be the golden ticket to securing a DSCR loan. Since DSCR loans focus on the property’s income-generating potential rather than your personal finances, a property with strong rent and low vacancy rates will naturally reflect in a higher DSCR. This sweet spot assures lenders that the rental income will reliably cover the loan payments, even with wiggle room for unexpected expenses.
Here are some factors to consider when shopping for a property:
- Properties that are already being used as rentals can provide a solid historical track record when it comes to rental income history
- Properties with more than 1 unit (2-4 unit properties) can help maximize DSCR with multiple streams of rental income
- Look for properties in areas with high rental rates, such as near university campuses or areas with a lot of young professionals
By prioritizing properties in desirable locations with proven rental histories, you’re essentially laying the groundwork for a strong DSCR and a smoother path to DSCR loan approval.
7. Understand the Loan Terms
Understanding the loan terms of a DSCR loan goes beyond just the minimum DSCR requirement. There are many other loan terms that you need to consider, such as interest rate options (fixed vs. adjustable), loan-to-value ratio (LTV) maximums, and prepayment penalties, so you can choose a loan structure that works best for you and your needs.
For example, choosing an interest-only loan during the initial years can lower your monthly payment, boosting your DSCR and making qualification easier. Similarly, understanding the LTV maximums set by the lender could potentially guide you towards properties that require a smaller down payment, which maximizes your available capital and potentially strengthens your overall application.
This understanding demonstrates to the lender that you’re committed to responsible investing and are willing to stay within your borrowing limits.
Pros and Cons of DSCR Loans FAQs:
- What are DSCR loans?
DSCR loans are non-QM loans (non-qualified mortgages) that use a property’s rental income to determine whether a borrower can qualify for a loan rather than their personal income. Since DSCR lenders don’t look at personal income, this means that borrowers don’t need to provide traditional income documents like W2s, pay stubs, and tax returns when applying for one.
- How do you calculate DSCR?
DSCR is calculated by dividing the annual rental income of the property by the annual debt service, including principal and interest, on the loan. Depending on the lender, property taxes and insurance may be included in the annual debt service calculation. If a DSCR is 1.0 or above, that means that the property is generating enough income to cover its debt payments, whereas a DSCR of below 1.0 indicates that its income isn’t enough to cover its debt.
- Who would benefit from getting a DSCR loan?
Real estate investors who have low personal income, non-traditional income streams, or those who want to qualify for financing based on the property’s cash flow can benefit from DSCR loans. Since DSCR loans focus on the property’s income instead, it opens up the door to a wider demographic of investors.
- What are the DSCR loan benefits?
DSCR loan benefits include:
- Using rental income rather than personal income to qualify
- No tax returns or other traditional income documents required
- Faster closing process
- LLC purchase
- Available for both novice and experienced real estate investors
- Build your rental property portfolio quicker – no hard limit on how many DSCR loans you can have
- Potential for higher loan amounts
- Options available for foreign investors
- What are the drawbacks of DSCR loans?
Some drawbacks of DSCR loans include:
- Limited availability
- Can have potentially higher down payments
- Non-standardized loan, so requirements and loan terms can vary significantly between lenders
- Risk of vacancy periods and real estate market conditions fluctuating
- Where can I get a DSCR loan?
DSCR loans are not offered by all banks and typically come from specialized lenders. Luckily, we here at Defy offer DSCR loans. If you’re interested, you can learn more by booking a call with us today.
- What minimum DSCR do lenders look for?
The minimum DSCR requirement varies by lender, but at Defy, we require a minimum DSCR of 0.75 to qualify.
- What’s considered a strong DSCR?
A DSCR of 1.5 or above is typically considered strong and indicates the property generates enough income to comfortably cover the loan payments.
- How can I improve my chances of qualifying for a DSCR loan?
Choosing a property with high rental income potential and maintaining your credit score can improve your chances of qualifying for a DSCR loan. If the property has a strong rental income history, this may help you qualify as well since there’s evidence of a proven track record.
- Can DSCR loans be used for primary residences?
No, DSCR loans are typically used for investment properties only, not primary residences. Since primary residences don’t generate income, DSCR can’t be calculated.
- What’s the difference between a DSCR loan and a conventional loan?
DSCR loans are non-QM loans that qualify borrowers based on the rental income of the property, while conventional loans are QM loans (qualified mortgages) that rely on the borrower’s personal income and employment history.
- What are some DSCR loan alternatives?
If you’re unsure if DSCR loans are right for you, the great thing about non-QM loans is that there are plenty of other options to choose from. Here are some other loans to consider:
- Bank Statement Loans: Qualify using your bank statements and your average monthly deposits.
- Profit & Loss Statement (P&L) Loans: Qualify using your business’ P&L statements.
- Fix-and-Flip Loans: Qualify based on historical experience and/or construction plans to purchase a property, fix it, and sell it quickly for a profit.
- Construction Loans: Qualify based on historical experience and/or construction plans to build a property from the ground-up.
- Asset Depletion Loans: Qualify using your liquid assets, such as bank, savings, and investment accounts.
