What Is a DSCR Loan? DSCR Loan Meaning + Requirements

Do you need bank financing for your next investment property but are worried about qualifying? A DSCR loan could allow you to secure financing without pay stubs, W-2s, or tax returns. In this article, you’ll learn everything you need to know about DSCR loans—including when to use one, how to get approved, and some other loan options you might be overlooking!

Summary:

• A DSCR loan is a mortgage where approval is based on the property’s income potential rather than the borrower’s personal income.
• DSCR loans allow you to borrow money without income verification, but they have higher interest rates and investment property down payments.
• There are several alternatives to DSCR loans, including Rent to Retirement’s 5%-down loan, which has lower interest rates and requires less money out of pocket.

What are DSCR Loans?

A DSCR loan is a mortgage designed for real estate investors buying income-producing properties. Approval is based on the property’s debt service coverage ratio (DSCR), a metric used to determine whether the property can generate enough income to cover its mortgage payment.

No Personal Income to Qualify (That’s Right!)

DSCR loans have become popular due to their unique qualification criteria. Unlike traditional investment loans, approval is based on the property’s current or projected income, meaning you could secure financing with low personal income or a high debt-to-income (DTI) ratio.

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The DSCR Ratio Formula 

Generally, lenders will want your property’s debt service coverage ratio to be above 1.25, meaning your net operating income (NOI) comfortably covers your total debt service—including principal, interest, taxes, and insurance (PITI). To calculate your property’s debt service coverage ratio, use this formula:

DSCR = Net Operating Income (NOI)/Total Debt Service

DSCR Example

Let’s say you’re buying an investment property for $500,000. Annually, it’s expected to bring in $42,000 in rent ($3,500/month), has $12,000 in (non-debt) expenses ($1,000/month), and will require $18,000 in total mortgage payments ($1,500/month).

First, deduct your expenses from rental income to determine your net operating income (NOI):

$42,000 - $12,000 = $30,000 NOI.

Then, divide your NOI by your mortgage payment:

$30,000 (NOI) / $18,000 (debt) = 1.66 DSCR!

The Pros and Cons of DSCR Loans

Is a DSCR loan the right option for you? Like any investment loan, there are several benefits and drawbacks to consider:

DSCR Pros

Many investors choose DSCR loans because they offer the following advantages:

No Personal Income Verification 

Lenders qualify you based on the property’s cash flow rather than your personal income. This means you can buy a property without providing pay stubs, W-2s, or tax returns!

Unlimited Property Loans

DSCR loans allow investors to buy multiple rental properties quickly, as there are no government caps on these loans. Compare this to conventional loans, where you’re limited to 10 properties!

Faster Approval

Most lenders verify your personal income through documents like tax returns, W-2s, and bank statements. Without all of the usual paperwork, you could get approved for a DSCR loan much faster!

DSCR Cons

The DSCR loan isn’t the ideal fit for all investors. Here are a few downsides to keep in mind:

High(er) Interest Rates

The convenience of DSCR loans comes at a cost, as interest rates tend to be higher than those of many other loan products. Expect your interest rate to be .5%-2% higher than conventional loans.

Large Down Payments 

While most investment properties require 15%-20% down, DSCR loans may require 20%-30% down. This means it could take longer to save up for your next investment property.

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Cash Flow Requirements 

Many lenders require at least a 1.25 debt service coverage ratio, meaning your property must generate enough income to cover the mortgage payment and then some.

Balloon Payments

DSCR loans often have shorter terms than other mortgages, with repayment terms ranging from five to 30 years. You may have a balloon payment at the end of the 5-10 year mark, at which point the entire loan balance will be due unless you refinance your loan or pay it off early.

DSCR Loan Requirements

Are you interested in getting a DSCR loan? While requirements vary from lender to lender, you’ll typically need to meet the following:

• 1.25+ DSCR: Most lenders will want your property to have a DSCR of at least 1.25.
• Credit Score: Lenders usually want to see at least a 620 credit score, but preferably 700+.
• Down Payment: While exact down payment amounts vary by lender and how much you’re looking to borrow, most lenders require 20%-30% down.
• Reserves: Lenders will want to see that you’ve got three to six months of mortgage payments saved in addition to your down payment and closing costs.
• Investment Properties Only: You can’t use a DSCR loan on primary or vacation homes.
• Entity Structure: Many lenders require you to hold your property in an LLC or corporation.
• Real Estate Experience: Lenders are more willing to lend to those who have successfully run investment properties before.

Best Properties for DSCR Loans

Which types of rental properties work best with DSCR loans? Here are a few top options:

1. Turnkey Rentals

Turnkey rentals are recently built or renovated properties that you can rent out for a profit. Because these properties require very little maintenance (if any) and often come with tenants already in place, you can cash flow from day one—making them great candidates for DSCR loans.

2. Long or Short-Term Rentals

DSCR loans are ideal for properties that generate predictable OR high income. Long-term rentals provide consistent monthly income, while short-term rentals are less consistent but have much higher revenue potential!

3. Commercial Properties

DSCR loans can be used to finance office buildings, self storage facilities, and other commercial properties. If the property meets the lender’s debt service coverage ratio threshold, you could qualify!

4. (Small) Multifamily Buildings

Small multifamily buildings are residential properties with up to four units. DSCR loans can be used for both residential and commercial use, as long as the property isn’t owner-occupied!

DSCR Loan Alternatives 

Do you want to use another type of loan for your investment property? There are several alternatives:

Rent to Retirement’s 5%-Down Loan

One of the biggest downsides of the DSCR loan is the large down payment. If you want to put as little money down as possible, consider Rent to Retirement’s 5%-down loan for new builds. Rent to Retirement also gets price discounts you can use to lower your down payment, buy down your interest rate, or get cash back at closing—effectively allowing you to buy a rental property with no money!

Conventional Loans

If the DSCR loan’s higher interest rates are the sticking point, you might opt for a conventional loan instead. These mortgages often have lower interest rates, but you’ll need to provide full income documentation.

Bank Statement Loans

If you’re self-employed, you may not have pay stubs or W-2s, and your tax returns may show less income than you actually earn after write-offs. A bank statement loan will use your personal or business bank statements to qualify you, but keep in mind that these loans have higher interest rates than conventional loans.

SBA (Small Business Administration) Loans

SBA loans can’t be used for residential investment properties like single-family homes and small multifamily buildings, but you can use them for “business” types of properties—like self storage facilities and office buildings!

Is a DSCR Loan Right for You?

DSCR loans can be a great financing option for investors with lower income or already-high debt-to-income (DTI) ratios, but they’re an expensive way to borrow money. If you want lower down payments and better interest rates on new-build turnkey rental properties, try Rent to Retirement’s 5%-down loan instead!

DSCR Loan FAQs

How Does a DSCR Loan Work?

With a DSCR loan, you’re approved based on the property’s income potential rather than your personal income. The lender will verify that the property’s rental income can comfortably cover your mortgage payment.

What is the Downside of a DSCR Loan?

The DSCR loan has a few downsides, namely its higher interest rates and down payment requirements. What’s more, you’re limited to income-producing properties and are unlikely to qualify if the property doesn’t cash flow right away.

Who is Eligible for a DSCR Loan?

To be eligible for a DSCR loan, you’ll need to be buying an income-producing investment property, have a decent credit score, and show that you have at least three to six months of reserves.

Are All DSCR Loans 20% Down? 

No, not all DSCR loans require exactly 20% down. Your down payment could be higher depending on a few different factors, such as your credit score and the property’s DSCR ratio.