DSCR Loan vs Conventional Loan
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Comparison Table - DSCR Loan vs Conventional Loan
DSCR Loans | Conventional Loans |
---|---|
Used to buy rental properties | Used to buy residential properties |
Easier to qualify for | More stringent approval criteria |
Based on debt service coverage ratio (DSCR) | Based on the borrower’s financial situation |
Higher down payment | Lower down payment |
Higher interest rates | Lower interest rates |
Fast closing time | Slower closing time |
Loan amount based on rental income | Loan amount based on property’s value |
Flexible loan terms | Fixed-rate or adjustable-rate mortgage |
DSCR Loan Definition
A Debt Service Coverage Ratio loan is, as the name suggests, based on the debt service coverage ratio. This ratio indicates an asset’s ability to meet its debt obligations by comparing these to its current cash flow. As such, DSCR loans are a form of financing used for real estate loans, that focus on a property’s ability to cover its debt obligations by generating sufficient income.
Unlike conventional loans, DSCR loans prioritize a property’s cash flow and financial performance which means a DSCR loan can be more flexible. These loans typically indicate whether a borrower is likely to be able to pay back the loan or not, based on the property’s rental income. Therefore, DSCR loans are well suited to real estate investing.
Conventional Loan Definition
A conventional or conforming loan is a loan that isn’t backed by the government, such as VA and FHA loans. Instead, conventional loans are provided by private lenders. They typically require a higher down payment of anywhere between 5% and 20% of the property’s purchase price. Conventional loans also demand higher credit score requirements, and specific loan limits that are set by the likes of Fannie Mae and Freddie Mac.
Conventional loans usually offer a variety of terms, such as fixed-rate and adjustable-rate. These are all impacted by the borrower’s creditworthiness, income, assets and collateral, as conventional loans are heavily based on the borrower’s financial situation.
Key Differences - DSCR Loan vs Conventional Loan
Difference 1: Rental Properties vs Residential Properties
DSCR loans are geared towards rental properties or commercial real estate, which means that the focus is on the rental income that the property produces and its ability to cover the debt incurred by the loan.
On the other hand, conventional loans are used for a variety of purposes, such as home purchases, refinancing and more. These loans aren’t necessarily tailored to income-producing properties, but rather to single-family homes, condominiums and townhouses.
Difference 2: Loan Approval Criteria
Non-traditional loans like DSCR loans typically don’t require stringent income verification, as they are based on the debt service coverage ratio. This means that loan approval is centered around the property’s income generation capabilities in relation to servicing the debt.
Whereas conventional loans place a large significance on a borrower’s credit, income verification, down payment and debt-to-income. The value of the property is a consideration for conventional loans, but by no means the most significant loan approval criteria.
Difference 3: Loan Terms & Closing Speed
DSCR loan terms can be flexible, based on the property’s rental income and cash flow. Loan terms on a DSCR loan can be tailored to the financial performance of the property, and these loans can be closed a lot faster than many other loan types.
Conventional loans have various loan terms on offer, but these terms still operate within the fixed-rate and adjustable-rate structures instead. Conventional loan terms are adapted to the borrower’s preferences and not the property’s cash flow. While their loan terms may offer options, they are generally still within a fixed structure.
Key Similarities - DSCR Loan vs Conventional Loan
Similarity 1: Income Verification
DSCR loans and conventional loans both require income verification. While there may be different levels of importance placed on this, both loans will require income verification, but in different forms.
DSCR loans will require income verification in relation to the property’s revenue stream, and conventional loans use income verification to assess the borrower’s overall financial stability in relation to paying back the loan.
Similarity 2: Property As Collateral
In the case of DSCR and conventional loans, the property is used to secure the loan. In other words, the property forms the collateral for the loan. Which means that if the borrower defaults on their loan or can no longer repay it, the property can be seized by the lender to recoup their losses.
DSCR loans are secured by a property that produces income, which means that the rental income is a significant factor in the loan approval process. Conventional loans also use the property to secure the loan, but this comes in the form of the financing of the property.
Similarity 3: Used To Fund Long Term Property Purchases
Both DSCR loans and conventional loans can be used for the financing of an investment property. While they may be aimed at different types of properties, eg: rental properties and single-family home purchases, both loans can used to purchase an investment property that will either earn an income or produce a profit for real estate investors.
Who Should Use DSCR Loans?
DSCR loans are geared towards properties that generate an income, and as such rental properties and commercial real estate are the best property types to use for these loans. DSCR loans can also be used to refinance existing properties. However, they cannot be used for purchasing a primary residential residence.
DSCR loans are great for real estate investors who are looking to finance multiple rental properties at once. Conventional loans typically only finance one property at a time, so real estate investors who would like to diversify their portfolio should consider using DSCR loans as they can finance more than one property at any time.
Those who need flexible loan terms that can be tailored to their unique needs and the investment property may want to use DSCR loans. The loan terms on DSCR loans are based on the property’s ability to generate an income, which means that the terms can be more flexible.
For real estate investors who require a faster approval process, DSCR loans offer a more streamlined closing process to help investors beat the competition. For deals that are time-sensitive, this can be a saving grace for investors.
DSCR loans are also better suited to borrowers who need a loan that’s easier to qualify for and isn’t based heavily on their financial situation or requiring a stellar credit history. For real estate investors who have a less desirable credit history, but have found a great rental property deal, DSCR loans are a good fit.
Who Should Use Conventional Loans?
Real estate investors who are looking for loans for other types of properties, outside of rental properties, can consider using conventional loans. Typically, these loans are best suited to residential property purchases, for single property purchases, as multiple properties cannot be financed by these loans.
Conventional loans have fewer restrictions on the use of funds, which means that they can be used to purchase primary residences, investment properties and refinance existing mortgages.
For borrowers with a good credit record and a stable income that they can verify, a conventional loan may be best. These loans require borrowers to have a stable financial situation, and suits borrowers who like a more structured approach to lending.
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Additional Resources
DSCR Loan Calculator
This DSCR Calculator makes it easy to workout DSCR Ratio, and it also estimate maximum loan amount and monthly repayments.
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 Pros & Cons
There are advantages and disadvantages associated with DSCR Loans. This guide outlines all the DSCR Loan Pros & Cons.
Best DSCR Lenders
Simply put, some lenders are better than others. This guide reviews the Best DSCR Lenders at this moment in time.
DSCR Loan For Airbnb
It is definitely possible to get a DSCR Loan For Airbnb properties. Short term rentals qualify for DSCR Loans.
DSCR Loan vs Hard Money Loan
This investor guide explains the key differences between a DSCR Loan vs Hard Money Loan.
Short Term Rental Loans (STR Loans)
Short term rental (STR) loans are tailored to the specific needs and challenges of the short term rental market.