DSCR programs are loan options for real estate investors where lenders qualify the deal based on the positive cash flow of the investment property.
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Real estate investing is an attractive and reliable way of building equity for the prudent investor. Even in a weak market, property values will continue to appreciate and provide dividends to the investor. However, breaking into the market to secure a property can be daunting. Lenders, also interested in the secure market of real estate, continue to diversify their products to give borrowers ins into this industry. One such option is the Debt Service Coverage Ratio Loan, or DSCR Loan.
These loans have only been increasing in popularity and for good reason. Designed to be available to first-time investors as well as seasoned real-estate gurus, their appeal is evident. Investors interested in the short-term rental sphere have been eager to use these loans to build mini-empires of vacation homes in some of America’s most popular tourist destinations.
So, how do these loans work and why are they so popular right now? Are they just for investors attempting to ride the potentially-volatile short-term rental market? Below is what you need to know about DSCR loans.
A DSCR Loan is a type of hard money no-income loan used to purchase real estate. It is originated based on the projected property’s cash flow, as opposed to a typical mortgage based on the income of the borrower. Because it is based on the cash flow of the property (or properties), a DSCR Loan is treated differently by lenders. For borrower’s this means they do not need to provide tax returns, pay stubs or prove their income to qualify for a loan amount.
Provided they can meet the requirements, DSCR loans can make for a unique benefit to individuals looking to expand their investment portfolios by buying into real estate. Not needing to provide tax returns can be very valuable for those self-employed or who typically take out many deductions on their tax returns which obfuscate their true income. For new investors it can be used to jump-start their real estate investments by avoiding the lengthy process most typical mortgages use. On average DSCR loans are approved in weeks, not months.
Experienced real estate investors can also see benefits to DSCR Loans too. We found lenders that can lend up to $5 million with good credit scores and sufficient down payments which can be used on multiple properties, not just one. This would allow a savvy investor to diversify their investment portfolio much quicker than applying for multiple mortgages.
DSCR Loans bear a lot of similarity to typical mortgages. They will require a down payment, charge annual interest, and will only be available to borrowers with decent credit scores. But while a typical loan program with require income verification, DSCR loans are investment property loans that use the property’s cash flow during underwriting to determine a borrower’s eligibility as opposed to a borrow’s income.
Financial institutions are always looking to diversify their investment opportunities. They see DSCR Loans as another tool to sell their products. These loans “work” because they don’t involve the lengthy process of evaluating a borrower’s personal income allowing for a quicker and more direct form of property lending.
Most hard money lenders let you choose between fixed-rate, adjustable-rate, or interest-only mortgages with your DSCR loan, allowing you the freedom to replay your debt however you choose with loan terms that make sense for your deal. The most popular type of DSCR loan is a 30-year fixed purchase, but our experience suggests there are many more options out there; suitable for any kind of buyer.
An additional perk is that properties can be owned by an LLC, which is unavailable to a traditional mortgage. This means that a borrower can use their home or side business to assist with their investment portfolio and can use funds from other entities tied to the business itself as start-up capital if needed. Note that a primary guarantor is still required for the loan. The bank won’t let you use an empty LLC as the sole obligor on the note.
Finally, unlike a typical mortgage, DSCR loans permit multiple property types such as properties with more than four units or non-warranted condos. This means you can expand your scope beyond the traditional SFR (single-family residence) properties.
Because DSCR loans are looking at the properties’ forecasted profits and not borrower income, they can be accessed by just about anyone interested in real estate investment. DSCR loans are not just eligible to citizens and green card holders but foreign nationals or non-permanent residents can also qualify for DSCR loans.
This means that, as long as the borrower can reliably prove that an investment property has earning potential, they can qualify for a loan regardless of any other qualifications.
In our research we found that qualifying for a DSCR loan is dependent on several factors; credit score, available funds for a down payment, and the properties’ DSCR ratio. We will discuss the calculation of a DSCR a little later. Sufficient principal and credit scores were the biggest limiting factor in getting approval for a loan in our searches,, so we will share what we found for those first.
Like a home mortgage, DSCR loans require good credit scores, at least 620-640 as a minimum. The lower your credit score, the more money a borrower will need to provide up-front. Additionally, the borrower will only be able to access a limited amount of loan capital. The lowest minimums we encountered required 40% as a down payment and only offered up to $1 million in loan opportunities.
There are many eligible property types, such as:
These properties can be used for long-term or short-term rentals (e.g. airbnb-style properties).
There are many ineligible property types, such as:
DSCR loans are also not typically used for spec home projects. If you are looking to build a single family house or multi-family property, you’re more likely to use a construction loan or a commercial construction loan depending on the nature of your project.
The DSCR is the ratio of operating income to debt obligations. It is a popular benchmark used in the measurement of a borrower’s ability to produce enough cash to cover their debt.
A “Good” DSCR ratio is usually one of 1.25 or above. This means the property is generating 25% more profit than expenses and has a positive cashflow. DSCRs above 1.25 typically have the best interest rates, require less capital for a down payment, and are more likely to be approved. Bad ratios, on the other hand, are anything near 1.0 and below, meaning the property has a negative cashflow.
There is no such thing as a minimum DSCR and a lower ratio does not automatically disqualify the borrower from a loan, but it will often come with additional restrictions. Additionally, the borrower may be required to commit to renovating the property as part of the loan so as to increase the revenue and thus increase the ratio back into the “good” category.
A DSCR ratio is calculated by finding the NOI, or net operating income, and dividing it by the Total Debt Service. Borrowers should be aware that each lender is likely to have a slightly different method of calculating the above two numbers. What we present here is similar, but borrowers should always inquire on exact numbers with their lenders.
In the simplest example we found, NOI is calculated as the properties’ annual rental income – the cost of operations. This number is then divided by the Total Debt Service which is calculated as the sum of your principal, interest, taxes, insurance, and HOA fees (if applicable).
This should give you a ratio, and that ratio is the DSCR.
For example; a Property’s NOI is calculated to be $16,000 per month. After various factors the Total Debt is calculated to be $12,000 per month. Dividing the $16k by the $12k we get a ratio of 1.33. This property earns 33% more per month than it expends.
Considering all the above information DSCR loans may seem appealing, but are they right for your investment portfolio? Let’s summarize the pro’s and con’s of a DSCR loan below.
Pros:
Cons:
As further comparison, let’s take into consideration what conventional loans offer.
Conventional mortgages conform to Fannie Mae or Freddie Mac guidelines. They are not backed by the federal government, but rather by private funds. Conventional mortgages will require credit checks to determine your interest rates. If used for property investment lenders typically require 30% down. Finally, as opposed to a DSCR loan, Mortgages will not consider rental income for the DTI (debt-to-income) calculations and they will require about six months of principal set aside to cover the debt obligations.
Who are the real-estate investors qualifying for DSCR loans? Below we provided some illustrations of typical borrowers so that you can understand the process more clearly.
Lewis is a self-employed Lawyer who has just started their journey of working for themselves. They have a little bit of cash saved up from their last job that was for their retirement, enough for a down payment on a house. They want to diversify their income with rental properties. Since their month-to-month income is somewhat fluctuating and requires a lot of deductions, it would be impossible to qualify for a normal mortgage. However, after researching they found a local condo near their cities’ downtown that they could afford the down payment for. A DSCR Loan makes perfect sense for Lewis because they can still qualify for a loan without showing their tax returns. All they would need to do is prove that the property will generate more profit than the taxes, interest, and local HOA fees.
Desire is a new graduate who has landed her first job in Big-Law and been recently married. She doesn’t have much cash right now and still needs to pay back her substantial student loans. However, she is sure that she wants to live in the city she grew up in and build a family with her partner. She has found a great house on the riverfront, but could never qualify for a conventional mortgage so early. A DSCR loan could be the answer for Desire’s problem. By borrowing for the down payment from her family she can rent out part of the property long-term and pay off the mortgage without taking on additional debt. This way Desire can focus on paying off her student debts in full before taking on a mortgage, while also securing her dream home.
Duarte has been a partner in Biglaw for many years now. He wants to secure his retirement in real estate, but doesn’t want to liquidate his current assets for a down payment. Duarte has an LLC formed with some friends he does side-business in. They are willing to put some of their own capital down towards this project. A DSCR loan can work for Duarte because LLC’s can qualify for DSCR loans. Duarte can get the properties in the LLC’s name using a down payment from his partners and begin the investment process now while keeping his current assets where they are.
Before committing to a DSCR loan it is always important to weigh the other options available to the savvy borrower. Below are some similar loans to the DSCR for your consideration.
This type of loan will use borrower-provided assets in order to secure a loan. It is almost exclusively used by businesses, so it is something for those in an LLC to consider. Liquid assets, those that can easily be converted into cash, are preferred and give the largest margins. Physical assets can also be used, but the loan will be less than the value of the assets provided due to the uncertainty of the deal.
Some additional considerations:
Bank Statement Loans allow the borrower to use their bank statements instead of tax returns. Like a DSCR loan, this is good news for investors who make a lot of deductions and write-offs which obfuscate their real income, such as self-employed business owners.
Some benefits to the Bank Statement loan are as follows:
However, Bank statement loans do have strict criteria to qualify. One potential hurdle is that borrowers will need to prove two years of sustained self-employment to qualify, any less won’t cut it. Loan interest rates are also likely to be higher too. Finally, as these loans are non-qualified loans, their eligibility is dependent on the mortgage lender.
Interest-only loans give investors the option to pay lower monthly payments for the first portion of the loan. During that time, the mortgage payments only apply to interest, not principal balance, with the assumption that the borrower will pay off the remaining principal at the end of the loan period.
Interest-only loans do come with some potentially steep downsides however. For example, because the borrower is only paying interest they are not contributing to the property’s equity. Not building equity means that the difference between the market value and mortgage can widen in a hot market, potentially losing money on the property in the long-term. This can also mean that when the time comes to pay the full loan the value of the property could have fallen leaving you with a property you owe more than it is worth.
These types of loans allow a borrower to qualify for a loan despite recent credit events like bankruptcy, short sale, foreclosure, and divorce. These loans are designed for borrowers with bad credit scores due to these events and can be useful for rebounding their portfolios. These loans are often available as soon as one has completed the credit event. Waiting at least two years after such an event is recommended, as it significantly affects interest rates. However, not everyone has the luxury of waiting that time, and that is where these loans shine.
Borrowers interested in this type of loan will need to pay close attention to the contents of the deals provided by the lenders. We noticed a great deal of different requirements, terms, and qualifiers for these loans that varied by lender. Borrowers should expect the process to take longer than a traditional loan and have higher interest rates.
Have you decided to go ahead and get a DSCR loan? If so, how much property can you afford? As stated before, your upper ceiling is dependent on your credit score and how much down payment you can provide. Additionally, you should consider your short- and long-term goals for these investments. Since real estate is illiquid, that is to say the investment may take months or years to unlock, you should consider the future needs for returns on your investments.
If you have decided to apply for a DSCR Loan, what are the next steps? The following section will walk you through the process of getting a DSCR mortgage loan started.
As with any investment, a team of professionals is a must to make the purchasing process streamlined. While you could go it alone, these professionals make the process simpler, faster, and can help you avoid potential pitfalls. According to Patricia McCoy, an analyst with Fitch Ratings, borrowers who qualified based on rental income are three times as likely to default (as compared to those with conventional mortgages).
A Real Estate Agent: Your real estate agent can help you decide many key factors related to your purchase, including how much investment properties you can afford.. They also act as your point person with everyone else on your team, making sure everyone is working together in your best interests.
A DSCR Loan Lender: You will also need the right lender; specifically, one that specializes in the origination of DSCR loans. These professionals can help size the loan to your needs, insure you get the best deal possible, and help you get an idea of the long-term implications of your loan.
Find 3 to 4 DSCR loan officers with whom you would like to work. These loan officers really just want a seat at the table with the option of closing on a mortgage. They will be amenable to negotiate and work with you and could also help you refinance or cash-out in the future.
An Appraiser: Running an appraisal on a property is an essential part of the property buying process. It ensures that the price you’re paying is comparable to similar properties in the area. An appraisal also protects the lender, giving them a realistic idea of their ROI in mortgaging a property to a buyer.
A Property Inspector: A property inspector will run the inspection on the location you eventually are interested in buying. This part of the process ensures that you are getting the most value for your money and also protects you from unpleasant defects in a property that you might not discover until after the sale is closed.
Before browsing potential properties we recommend getting pre-qualified for a loan. This process is quick and doesn’t require a credit check. The mortgage lender will get to understand your financial situation, then confirm that you are likely approved for a DSCR loan. They may provide you with a pre-qualification letter as well that includes an estimated amount for which you would be approved. This letter is used when viewing properties and making offers.
The next step is to get pre-approved. It is a confirmation from the lender that you will receive the loan. This process will have the lender assessing your credit score and the potential DSCR ratio of the property. Other questions that might come up include:
What kind of credit do you have? What is the long-term history of that credit? How many properties are you interested in purchasing?
Once you have a pre-approval your real estate agent can start taking you to view properties in your preferred area. Trusting your real estate agent in this stage is critical, especially if you are looking for properties distant from your current dwelling. Ensure you see several properties at this stage. You will want to have plenty of options open to you to ensure the rental property can fulfill its debts.
Finally, it is time to make an offer for a property. Trust your real estate agent during this time, as their experience is invaluable. They will be the best person to ensure your offers are as appealing as possible.
When the time comes to sign the contract, ensure you review everything thoroughly. At this point some investors will even involve attorneys during the contract review, just to ensure everything is up to snuff. Your real estate agent is a helpful guide at this time as well.
Go back to the 3-4 loan officers you met at the beginning of the process who have a seat at the table and see what their counteroffers may be. You will want to weigh all their options and review the terms thoroughly. Remember that they all want your business and will be motivated to give you the best offers possible, so make sure that you comparison shop.
Joshua Holt is a licensed mortgage loan originator (NMLS #2306824) and founder of Biglaw Investor. His mortgage expertise lies in the areas of professional mortgage loans, particularly for lawyers, doctors and other high-income professionals. Prior to Biglaw Investor, Josh practiced private equity mergers & acquisition law for one of the largest law firms in the country.
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