The Complete Guide to DSCR Loan Down Payments
In the world of real estate, down payments are an essential part of purchasing a new property. While DSCR loans can be a great tool for financing a new investment property, they work differently than a traditional mortgage, which means the factors that affect a DSCR loan down payment are different as well.
For real estate investors who are interested in getting a DSCR loan, putting together a DSCR loan down payment can feel overwhelming, but it doesn’t need to be. That’s why we put this together. Several questions might be running through your mind, such as: How much do I need to put down? What factors affect a DSCR loan down payment? What are the advantages of making a DSCR loan down payment?
If you’ve been exploring DSCR loans and are looking to learn more about how DSCR loan down payments work, you’ve come to the right place. In this article, we’ll be covering everything you need to know about DSCR loan down payments.
How Do DSCR Loans Work?
DSCR loans, short for debt-service coverage ratio loans, are commonly used for income-generating or investment properties. The DSCR metric gauges the property's ability to make sufficient income to cover its debt obligations. This ratio provides lenders with insights into the property's risk profile without factoring in the borrower's income or credit score as part of the eligibility criteria. When analyzing DSCR, a higher value is preferable, signaling strong financial performance for the property.
DSCR loans can be appealing to real estate investors because the eligibility criteria heavily focuses on the property’s income potential, rather than the borrower’s. Additionally, these loans are highly specialized, featuring tailored terms and conditions crafted to align with the property's income-generating potential.
What Is the DSCR / Debt Service Coverage Ratio?
Debt Service Coverage Ratio (DSCR) is a metric that’s used by lenders to determine whether an investment property is generating enough income to cover its debt payments. DSCR is calculated by dividing the property’s net operating income (NOI) by the total debt service (including interest and principal payments).
The Debt Service Coverage Ratio (DSCR) serves as a tool for lenders to assess whether a property generates enough income to sustain itself financially. A DSCR exceeding 1 indicates that the property generates adequate income to fulfill its debt obligations. Conversely, a DSCR below 1 suggests that the property lacks the necessary income to cover its debt payments entirely.
What Are DSCR Down Payment Requirements?
While DSCR down payment requirements may vary between lenders, most of them only allow a minimum of 20% down or a maximum loan-to-value (LTV) of 80%. Depending on other factors like your credit score and the DSCR of the property, the down payment amount can go up to 30%. Although this is what you’re likely to find with other lenders, at Defy, we go as high as 85% LTV, meaning that you can qualify for a DSCR loan with less money down.
If you’re shopping around for DSCR loans, be sure to discuss with your lender how much of a down payment you’re expected to put down to avoid any surprises. The DSCR down payment percentage is heavily dependent on a multitude of factors, so the best way to find the exact amount for your specific situation is to contact lenders directly. This way, you’ll get a more accurate figure and can plan accordingly for the amount that’s required.
What Factors Affect DSCR Loan Down Payments?
When it comes to determining DSCR loan down payments, lenders typically use a multi-faceted approach and take several factors into consideration. While there isn’t a universally applied set of factors that affect DSCR loan down payments, here are some key factors that lenders usually consider:
- Credit Score: A higher credit score indicates lower risk and may contribute to a lower down payment
- DSCR: A stronger DSCR shows that the property is able to pay for itself with an additional buffer, which means a lower risk of default
- Property Location: Properties in desirable markets with strong rental demand and lower vacancy rates can potentially lead to lower down payments
- Loan-to-Value (LTV) Ratio: Most lenders have a maximum LTV that have to follow as part of their policies to limit their risk exposure
Advantages of Making Down Payments on a DSCR Loan
Although a down payment might not be ideal if you’re low on capital or want to free up some cash, making a down payment can be a good thing for borrowers. Putting money down for a DSCR loan can help you build home equity and reduce your monthly payments. On top of that, a larger down payment lowers your LTV and signals to lenders that you’re committed, which to them indicates a lower risk of default.
Below, we go more in-depth about each advantage of making a DSCR down payment:
- More Equity
Making a larger down payment for your DSCR loan means that you’ll have more equity in the property. The equity you have on a property is calculated by subtracting the amount that’s still owed from the property’s market value. With a larger down payment, you’ll have less owing on your mortgage, effectively increasing the equity you have in the house.
Why does equity matter? Having more equity in the property can be beneficial for a couple of reasons. Firstly, if the real estate market takes a tumble and housing values decrease, having that equity in your home acts as an extra cushion against any risk of negative equity. Negative equity is when you owe more on your property’s mortgage than it’s currently worth in the market. Secondly, if you’re looking to apply for any loans in the near future, having additional equity in the house will make you more likely to be approved for another loan.
- Lower Monthly Payments
Putting down a larger amount will help you lower your total loan amount on the property, which will result in lower monthly payments. Not only does it reduce how much debt you have, but it also reduces the interest you’re paying every month since the interest is calculated on a lower outstanding balance. Lower monthly payments can also be beneficial for borrowers who are looking to take out other loans in the near future since they’ll contribute to a lower debt-to-income (DTI) ratio, which is a metric that’s often looked at for traditional loan eligibility.
Since DSCR loans are typically used by real estate investors, having a lower monthly payment will positively impact your cash flow and put more money into your pocket.
- Better Chance of Approval
Contributing a larger down payment can help increase your chances of getting approved for a DSCR loan. Putting down a larger amount signals to lenders that you’re financially stable and are more likely to repay your loan on time. It also shows lenders that you’re committed to the success of the property since you’re making a significant upfront investment.
- Less Default Risk
From a lender’s perspective, if a borrower puts down a larger down payment, they’re seen as less likely to default or not repay their loans. This is due to having more “skin in the game” with a significant amount of money being tied into the property. Since lenders consider a larger down payment as an indication of lower default risk, they’re more likely to approve the loan.
Alternatives to DSCR Down Payments
If you’re interested in purchasing a property using a DSCR loan, but the down payment amount is holding you back, there may be other, more suitable options for you. Depending on your circumstances, you might not have to put down such a large down payment if a different loan type is a better fit for you than a DSCR loan.
Below, we’ve outlined some alternative options:
- Traditional Loan Options
Instead of a DSCR loan down payment, you can explore your traditional loan options if you’re looking to purchase a property. Traditional loan options include conventional and government-backed loans, and they typically offer lower down payment requirements in comparison to DSCR loans. These can be a good option for borrowers who don’t have substantial funds available for a large down payment. Additionally, these loans are usually used for purchasing primary residences, whereas DSCR loans are catered more towards real estate investors. However, traditional loans tend to have stricter criteria since they follow the lending standards of government agencies like Fannie Mae and Freddie Mac.
- Non-QM Loan Options
In the lending world, the term non-QM refers to loans that don’t follow the lending standards set by Fannie Mae and Freddie Mac. This means that lenders have more flexibility in determining their own lending criteria when issuing loans to borrowers. Since a DSCR loan uses the property’s income to determine eligibility instead of the borrower’s income, it’s considered to be a non-QM loan. In addition to DSCR loans, there are many other non-QM loan options available depending on your needs, including:
- Bank statement loans
- Asset-based loans
- Fix-and-flip loans
- Interest-only loans
- Foreign national loans
- Proft & loss statements
- Construction loans
- Seller Financing
Another alternative to the DSCR loan down payment is seller financing, which is when the seller of the property agrees to finance part or all of the purchase price. Depending on the agreement with the seller, this could potentially allow the borrower to avoid a down payment entirely or have it significantly reduced. While uncommon, it’s another option that might be worth exploring if you’re strapped for cash and want to try avoiding a down payment.
Best Markets for DSCR Loan Down Payments
Generally, the best markets for DSCR loans are metropolitan areas with growing job markets, low unemployment rates, and a strong renter base such as California, Texas, New York and Tennessee. On top of that, areas with population growth and a diverse economy tend to have more opportunities for successful rental properties.
Some other market factors to consider are:
- High Rental Yields: Look for markets with DSCR ratios that are above the minimum requirement.
- Low Vacancy Rates: Indicates a strong renter base and reduces the risk of income gaps.
- Large Tenant Pool: Markets with a diverse economy and a variety of industries reduce the risk of vacancy during economic downturns.
- Appreciation Potential: Areas that have consistent property value growth can offer additional returns.
Do You Have to Have a Down Payment for a DSCR Loan?
Yes, a down payment is required for a DSCR loan.
DSCR Loans With No Down Payment: Do They Exist?
Typically, no, DSCR loans will require a down payment. Only in very specific and rare circumstances can a borrower get a DSCR loan with no down payment.
How Much of a Down Payment Is Required for a DSCR Loan?
A down payment of 15-30% is common for a DSCR loan depending on several factors, such as the property’s DSCR and the borrower’s credit score.
Can You Get A DSCR Loan With 10% Down?
Most lenders will require at least 20% down, which means that generally, you can’t get a DSCR loan with 10% down. However, in certain situations like having a strong borrower profile, experience with rental portfolios, and a desirable property, some lenders might be willing to offer a reduced down payment.
Can You Get A DSCR Loan With 15% Down?
Most lenders will require at least 20% down, which means that generally, it will be much more difficult to get a DSCR with 15% down. However, in certain situations like having a strong borrower profile, experience with rental portfolios, and a desirable property, some lenders might be willing to offer a reduced down payment.
How Do You Calculate the Down Payment for a DSCR Loan?
You can calculate the down payment for a DSCR loan by multiplying the purchase price of the property by the down payment percentage required for your loan.
What Factors Affect DSCR Down Payment?
The main factors that affect the DSCR down payment are:
- DSCR of the property
- Location of the property
- Borrower’s credit score
Does Credit Score Matter?
Yes, your credit score matters. A higher credit score will usually result in a lower, or even the minimum, down payment. Whereas, a lower credit score will require a larger down payment.
DSCR Loans With No Credit Check: Do They Exist?
It’s unlikely to get a DSCR loan with no credit check. Some DSCR lenders may offer alternatives to a credit check, such as asking for tax returns or bank statements, to evaluate financial stability. However, these alternatives might come with trade-offs like stricter qualifications or higher costs due to higher risk for the lender.
How Can You Reduce My DSCR Down Payment Amount?
You can try to reduce your DSCR down payment amount by maximizing the incoming cash flow to increase the property’s DSCR or improving your credit score.
Is There DSCR Down Payment Assistance Available?
No, unlike other loan products, there are no down payment assistance programs to help with the down payment.
How Do You Calculate DSCR on a Loan?
DSCR is calculated by dividing the property’s net operating income (NOI) by the total debt service (including interest and principal payments).
Can You Get a Loan for a DSCR Loan Down Payment and Closing Costs?
Depending on the lender, it might be possible to roll over your closing costs into the loan. In terms of down payments, most lenders won’t accept funds from another loan to cover a down payment.
Is a Down Payment Deducted From the Loan Amount?
Yes, a down payment is deducted from the purchase price of the property, which reduces your total loan amount.
Where Can You Get a DSCR Loan?
You can get a DSCR loan from a variety of different lenders including traditional banks, credit unions, private lenders (like us at Defy Mortgage), and specialized lenders.