What Is a DSCR Loan?
Maybe you’ve got your eye on that adorable little cottage on the corner. You think it’d drive renters wild, but your bank account isn’t in the best shape for you to buy it. Now what?
Enter DSCR loans, which are a special type of loan that’s based on the investment value of a property instead of your personal income.
What is a DSCR loan, and how can you apply for one? We explain all you need to know below. You’ll also discover some of the perks and drawbacks of DSCR loans to help you decide whether applying for one makes sense for you.
What Does DSCR Mean?
DSCR stands for “debt service coverage ratio.” Lenders use DSCR to calculate the potential cash flow value of a property. To calculate the debt service coverage ratio, lenders divide the net operating income by the monthly payment (PITI) for the property.
“Net operating income” refers to the amount of rental income you’ll earn monthly minus expenses such as repairs, property management, etc.
Lenders usually look for a DSCR of at least 1.2. Such a ratio indicates that your income will be higher than your expenses.
What Is a DSCR Loan?
A debt service coverage ratio (DSCR) loan, which you might also see referred to as an investor cash loan, is a loan based on the potential cash flow of a property instead of your income.
A DSCR loan is a non-QM loan or non-qualified mortgage loan. Non-QM loans are a lifesaver for people who don’t meet the requirements for a traditional mortgage. Other types of non-QM loans include 1099 mortgages, foreign national loans, and ITIN loans.
How Does a DSCR Loan Work?
When applying for a DSCR loan, your mortgage lender will consider the potential cash flow value of the property (minus operating expenses) divided by the monthly payment.
If approved for the loan, you’ll make monthly payments just as you would with a traditional loan. The only difference is that you will use your rental income to make payments on the loan.
DSCR Loan Requirements
To qualify for a DSCR loan, you’ll generally need a loan-to-value ratio (LTV) of 80% or less. If your ratio is higher, this indicates that the size of the loan is higher than the home’s value.
You might also need to supply a down payment on the property or undergo a credit check for approval. Exact requirements vary by lender.
Many lenders also require at least some experience with investment properties before they will approve a DSCR loan.
You might also need to have:
- A lease, if the property is currently occupied
- Property insurance
- Two months of bank statements
- Entity documents, such as a Certificate of Good Standing (if you’ve set up an LLC)
- Renovation documentation
How To Apply for a DSCR Loan
Now that you know the answer to “What is a DSCR loan?,” here’s how to apply for one.
- Find a lender that offers DSCR loans. Not all lenders offer non-QM loans, so you’ll need to shop around for one that does.
- Complete a loan application online or in person with a loan officer.
- The lender will review your application and determine whether you meet the loan requirements.
- If approved, you’ll lock in your interest rate for the loan. Once you receive the loan, you’ll have to make monthly payments as outlined in your repayment terms.
Advantages of DSCR Loans
DSCR loans outshine traditional loans in quite a few ways. Some of these include:
- They’re ideal if you lack the cash to purchase a property outright or your personal income isn’t high enough to qualify for a traditional loan.
- Found a rental property that you can’t wait to grab? The approval time for DSCR loans is generally shorter than that for regular loans.
- You’ll enjoy a flexible underwriting process. Lenders can give loans to borrowers who wouldn’t normally qualify.
- DSCR loans require less documentation compared to other types of loans.
- There’s no limit on the number of DSCR loans you can have at one time. You can get a DSCR loan for one property, 10 properties, or potentially more.
Disadvantages of DSCR Loans
Although DSCR loans offer plenty of perks, they do have some drawbacks, just like any other type of loan. These include:
- You’ll usually need to have enough cash to meet the lender’s down payment requirements. Most lenders will require a down payment of 15% to 25% of the property’s value.
- Some lenders require you to have a high credit score. Depending on the lender, you may need a credit score of 650 or higher.
- DSCR loans aren’t available for all types of properties. You can’t get a DSCR loan for homes with single-room rentals, multi-family homes with more than four units, manufactured homes, or agricultural properties.
- Lenders will often require you to have at least three to six months of cash reserves to cover repairs or vacancy issues.
- You cannot get a DSCR loan for a property that you’re living in. DSCR loans are only for income-producing properties.
- DSCR loans often come with prepayment penalties. This means you’ll owe a penalty if you pay off the loan early.
Who Can Benefit From a DSCR Loan?
You could benefit from a DSCR loan if:
- You want to invest in real estate but lack the personal income to purchase a rental property.
- You’re having trouble qualifying for a traditional loan.
- You have cash reserves to cover loan payments if the property sits unoccupied for several months.
- You’re self-employed. DSCR loans are easier for self-employed individuals to get compared to traditional loans.
- You’re investing with a partner. DSCR loans allow you to borrow in an LLC or partnership and share ownership.
DSCR Loan vs. Traditional Loan
Here’s a quick rundown on DSCR loans vs. traditional loans.
DSCR loans:
- Used for rental properties
- Doesn’t require income verification or a job history
- Quick to qualify for
- Available for high-value properties ($1 million or more)
- Interest-only options are available
- Available to partners and LLCs
- Loan amount is based on potential rental income
Traditional loans:
- Used for your primary residence
- Require income verification and a stable job history
- Can take longer to qualify for
- Lower down payments and interest rates
- Loan amount is based on the property’s value
Common Misconceptions About DSCR Loans
There are quite a few myths and misconceptions about DSCR loans. Some of them include:
- DSCR loans are hard to get: DSCR loans can actually be easier to qualify for than traditional loans. You will need a fairly high credit score, but lenders don’t consider your personal income when deciding whether to approve you.
- DSCR loans are only for fancy, expensive properties: You can get a DSCR loan for homes of any price or size. As long as the home’s value is more than the loan, the sky is truly the limit.
- DSCR is the only metric that matters: DSCR is important, but it isn’t the only metric you should pay attention to. Occupancy rates, market trends, and property location are key metrics to focus on, too.
Tips for Getting Approved for a DSCR Loan
To maximize your chances of getting approved for a DSCR loan, follow these tips:
- Before applying, look for ways to boost your rental income and lower your debt. For example, you might pay down credit card balances or raise the rent.
- Know your credit score before submitting your application. If it’s below 680, the lender likely won’t approve you. You’ll need to find ways to boost your credit score first.
- Prepare detailed financial documents for the lender to review. You’ll need recent tax returns, operating statements, rent rolls, and other financials that reflect your rental income and expenses for the property.
- Choose a lender that specializes in DSCR lending. Such a lender knows the ins and outs of DSCR loans and will guide you through the application process.
- Prepare a backup plan in case you’re not approved. Other financing options include conventional loans, equity partnerships, and private money lenders.
Start Your Investing Odyssey Today
What is a DSCR loan? It’s your ticket to investing success! Reach out to A and N Mortgage Services at (773) 305-5626 to learn how we can help.
FAQs
Learn more about DSCR loans below.
Can I Use a DSCR Loan for My Primary Residence?
You cannot use a DSCR loan for your primary residence. That’s because DSCR loans are only for income-producing properties.
Can I Refinance My Current Mortgage With a DSCR Loan?
You can easily refinance a current mortgage with a DSCR loan. Doing so is a smart way to free up equity in a property and boost your cash flow. However, tread carefully because you might have to pay a prepayment penalty if you refinance.
Are DSCR Loans Available for Commercial Properties?
Yes, it’s possible to get a DSCR loan for commercial properties. In fact, DSCR loans are only available for income-generating properties, not primary residences.
Want more answers to the question, “What is a DSCR loan?” Call A and N Mortgage Services today.
