DSCR Loan Pros And Cons

What Is A DSCR Loan?

A DSCR loan is a Debt Service Coverage Ratio loan. This loan type is geared towards real estate investors and focused more on the debt service coverage ratio (DSCR) of the investment than the borrower’s personal income. This means that a DSCR loan is based on the property’s income generation being able to cover the debt, instead of the investor’s ability to pay off the loan in their personal capacity.

The investment property’s cash flow is the main component of a DSCR loan. This helps lenders and investors figure out whether the property’s net operating income (NOI) will cover the debt obligations of the loan. DSCR is the ratio used to measure cash flow, and it can be worked out by dividing the NOI by the amount of debt, on an annual basis.

Typically, lenders who provide DSCR loans are looking for a ratio of 1.2 or more. Any debt service coverage ratio over 1 means that the debt can be covered by the income of the rental property. A ratio of 1.2 or higher means that borrowers will be able to cover their debt and have money left over from the property’s income. In other words, the higher the debt service coverage ratio, the lower the risk for DSCR lenders.

DSCR Loan

30- year fixed DSCR Loan for stabilized rental properties

Interest Rate

from 7.5

Origination fee

2-3%

Loan To Purchase Price

up to 80%

Loan To Value

up to 80%

Minimum DSCR

None

Term

30-yr fixed rate

Minimum Loan Amount

$150,000

Maximum Loan Amount

$3,000,000

Minimum FICO

660

Type of Property

Residential 1-4 units

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DSCR Loan Pros And Cons

Most financing tools come with both pros and cons, and a DSCR loan program is no different. Let’s take a detailed look at the benefits and drawbacks of a Debt Service Coverage Ratio loan.

DSCR Loan Pros

  • Personal Income Isn’t A Key Qualification Component: instead these loans are based on the cash flow of the rental property. If the net operating income can cover the debt with money to spare, it means the rental property has a positive cash flow and the loan is very likely to be approved.
  • No Income Verification: There is no employment check or income verification.
  • No Property Limit: There is often no limit to the number of properties that you can get financed with a DSCR loan. Many other conventional loans will place hard limits on the number of properties that can be financed, so this makes DSCR loans an attractive option for those wanting to expand their portfolio.
  • Can Fund Different Property Types: DSCR loans can be used for a variety of properties such as single-family residential properties, short-term and vacation rentals, commercial and multi-family properties.
  • No Reserves Required: For cash-out loans there are generally no reserves required (in most cases).
  • Analyzed & Approved By People: DSCR loans are typically approved by people, and not put through computer systems where deals need to match specific criteria to be approved.

DSCR Loan Cons

  • Difficult Loan Terms: The loan terms can be more difficult to meet than conventional loans, in terms of down payments and interest rates.
  • Lender Fees: Most DSCR Lenders charge loan origination fees which are extra costs, on top of the principal loan amount and interest.
  • Loan Limits: Less financing may be provided when compared to other loans as DSCR loans tend to provide a limit that can be anywhere between $2 million and $5 million.
  • Down Payment: Most DSCR Lenders will require a down payment. The down payment is usually 20% of the rental property purchase price, but it can be higher or lower than this, depending on the loan provider that you select.
  • Minimum Credit Score: In order to mitigate the risk of a borrower defaulting on the loan, most lenders have a minimum credit score requirement that the real estate investor must meet in order for the loan to be granted.
  • Loan-to-Value Ratios: DSCR loans usually have Loan-to-Value ratios of 75% to 80%.
  • Minimum DSCR: Some DSCR lenders require a service coverage ratio DSCR of 1.25 to 1.5 for investors to meet the basic requirements. They may be quite stringent about this rule, and this is common across most lenders. With that being said, forward thinking lenders like New Silver offer a DSCR Loan program with no minimum DSCR.
  • Interest Rates: The interest rates on DSCR loans are generally higher than traditional mortgages.
  • Less Consumer Protection Than Regular Loans: DSCR loans aren’t a Federal offering, which means that these loans are not bound by the same federal consumer protection regulations.

Benefits of DSCR Loans

Now that you know more about DSCR loans, let’s take a look at the benefits that these loans can offer real estate investors.

  • Easier to qualify: Due to the fact that DSCR loans don’t place a huge importance on an investor’s personal financial situation, it’s easier to qualify for them. A real estate investor simply needs to find a profitable investment property deal. They also won’t need a large amount of liquid capital upfront. This is particularly useful for those who are self-employed.
  • Less documentation: With little to no personal income information needed, there is less documentation to supply. This saves time and energy for investors who won’t need to prove their income, provide their employment history, and a host of other documents.
  • Quicker applications: Less documentation means that real estate investor can move through the application process much faster than a conventional loan as there is less to process. The decision can be made quicker based on the vital DSCR information of the investment property.
  • Invest in multiple properties at once: With little to no limit on the number of properties that can be financed with DSCR loans, investors can purchase multiple properties at the same time. A DSCR loan doesn’t require investors to pay off one property before purchasing another, which is a big plus for investors who would like to expand their real estate portfolio quickly.
  • Suited to new or seasoned real estate investors: With personal income taking a backseat, this means that DSCR loans are suited to investors who are just starting out, as well as investors who have years of experience already.
  • Long and short-term rental properties are eligible: DSCR loans can be used for various property types, including short-term rental properties like AirBnb, long-term rentals and commercial property.
  • Approval according to the deal: DSCR loans are reviewed and underwritten by people who can approve loans that may not fit the exact requirements but are still strong deals. This is a great benefit for investors who have found a good deal that may not quite match the application criteria entirely.

Disadvantages of DSCR Loans

Along with the benefits, there are some drawbacks to DSCR loans, so be aware of these before you go down this route.

  • Down payments: The down payments on DSCR loans are typically 20% or more, which can be a lot of money to have readily available. Not all investors can fork out this much, which can be a deterrent for some people.
  • 6 months’ cash reserves: Cash reserves are sometimes required for DSCR loans that are not cash-out refinancing. Not all investors will have 6 months of cash reserves on-hand so this can be a problem for those looking to use DSCR loans.
  • LTV ratios are under 80%: LTV ratios are typically 75% to 80% for DSCR loans, which is the amount being borrowed divided by the appraised value of the property. This means that whatever is left, will need to be paid as the down payment.
  • High DSCR required: A DSCR of 1.25 is considered good, while over 1.5 is considered great and preferable for DSCR loans. However, for investors who are in an expensive real estate market, this can be difficult to achieve. The rental income of the property will essentially need to cover the debt and expenses and leave at least another 25% to 50% of funds. This isn’t always possible, based on the local real estate market, in which case investors may struggle to qualify for a DSCR loan.
  • Higher interest rates: The interest rates on DSCR loans can be between 7% and 9%, which is substantially higher than conventional mortgages. This can leave investors having to pay larger monthly payments for their loan and paying more for a DSCR loan overall, in comparison to the monthly mortgage payment on a traditional loan.
  • Empty homes may be harder to finance: If there are no tenants in the property, it is more difficult to estimate the cash flow of the property correctly, and therefore give an accurate DSCR. As such, lenders are often more inclined to give loans to those who can prove that their cash flow will be enough to cover the debt, based on actual rental income amounts.
  • Pre-payment penalties may apply: Due to the fact that DSCR loans aren’t backed by the Federal government, pre-payment penalties may be charged to those who want to pay off the loan early.

Are DSCR Loans Risky?

While DSCR loans are more expensive than some other loan types, the higher the debt service coverage ratio, the less risky the loans are for investors. There are higher interest rates and down payments on these loans which also compensate for the risk involved for lenders. For a real estate investor, there is less risk, as they can get a loan based on the property’s cash flow instead of their own finances.

Should You Apply For A DSCR Loan?

Real estate investors who are looking to build their portfolio of rental properties could benefit from DSCR loans thanks to the speed of closing and the deal-focused application requirements. These loans are ideal for investors who have found great deals but do not have the required personal income to cover the debt obligations, such as new investors.

A DSCR loan can be a powerful investing tool, however these loans come at the price of a higher down payment and higher rates. So, for investors who don’t have the cash to pay a 20% down payment and would prefer a lower monthly installment, this may not be the best financial solution.

It’s a good idea to take a close look at your investing needs, as well as the potential cash flow of the property, and weigh this against the requirements for a DSCR loan. If you feel that these all align, this could be the solution for you.

Additional Resources

DSCR Loan

A DSCR Loan is a unique loan product designed specifically for real estate investors. The cash flow status of the rental property is incorporated into the loan terms. It is very well suited to rental property investors.

DSCR Loan Interest Rates

Find out the latest DSCR Loan Interest Rates here. This guide explores what rate you are likely to qualify for.

DSCR Loan Requirements

First and foremost there must be a rental property to evaluate, but there are other DSCR Loan Requirements.

DSCR Loan Calculator

This DSCR Calculator makes it easy to workout DSCR Ratio, and it also estimate maximum loan amount and monthly repayments.

Best DSCR Lenders

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DSCR Loan vs Conventional Loan

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