A DSCR (debt service coverage ratio) loan, or Investor Cash Flow loan, is a non-QM loan that allows you to qualify for a home loan without relying on personal income.
DSCR loans are perfect for real estate investors who can secure a real estate loan based on their rental property’s cash flow, not their income tax returns or other financial paperwork. Here’s how a DSCR loan works and what it takes to qualify.
How Does a DSCR Loan Work?
A conventional loan requires proof of income, usually in the form of tax returns or pay stubs. Alternatively, DSCR loans allow buyers to qualify for a mortgage based on their rental property’s cash flow.
Instead of using income to qualify a real estate investor for a loan, mortgage lenders will look at what is called a debt service coverage ratio or DSCR ratio. This ratio gives lenders insight into whether or not a borrower will be able to use the rental income from the property to cover their monthly loan payments.
In addition to the DSCR ratio, investors may also have to meet certain credit score credit score requirements or even offer a down payment, though the exact requirements vary between lenders.
There is no limit to the number of DSCR loans you can qualify for. This means that investors who own multiple real estate properties can take out multiple loans to generate income from many tenants. This feature makes this a flexible option for beginner investors as well as seasoned real estate professionals.
The DSCR Ratio
To qualify for a DSCR loan, lenders require you to have a healthy DSCR ratio. This ratio relates the income of the property to its total debt, which influences the eligibility for the DSCR loan.
A good DSCR ratio is usually one or above, though lenders can be flexible depending on other criteria. To calculate your DSCR ratio, simply use the following DSCR formula:
DSCR = Monthly Rental Income / PITIA (Principal, Interest, Property Taxes, Homeowners Insurance & Association Dues)
Who Are They For?
DSCR loans are for investors in residential real estate rentals. They are a great option for anywhere from first-time investors to experienced investors with a large existing portfolio.
Investors can use DSCR loans to purchase additional income-generating properties, which makes this an ideal loan type for those looking to tap into additional revenue streams.
What Is A Non-QM Loan?
A DSCR loan is a type of non-QM loan non-QM loan, or non-qualified mortgage loan. These are loan products tailor-made for borrowers who may not fit the usual criteria for a traditional mortgage. These loans tend to have different requirements when it comes to income and credit.
In addition to providing loans for real estate investors, non-QM loans have solutions for self-employed borrowers, gig workers, or foreign nationals. They include:
More: What Is A Non-QM Loan?
This guide will help you learn more about non-traditional loan programs that match your financial situation.
Find The Right Loan For You
How to Qualify for a DSCR Loan
To qualify for a DSCR loan, lenders have specific criteria for both you and the property in question. Here are the DSCR loan requirements borrowers must meet.
DSCR Loan Requirements
Lenders will start by confirming the borrower’s ability to repay the loan. While specific requirements vary by the lender, most borrowers can expect to meet the following criteria:
- DSCR ratio of 1.0 and above
- Credit scores of at least 620 (though some lenders require higher scores)
- A down payment of 20% (though some lenders may have lower requirements)
- A minimum loan amount of $100,000
- A maximum loan amount of $3 million
Again, these requirements vary between lenders, and some may be willing to work with borrowers with different credit histories depending on the property.
In addition, lenders may also vary on the minimum and maximum loan amounts, but keep in mind that since DSCR loans are aimed at income-generating properties, you may find a narrower range than in a conventional mortgage loan.
As for the property itself, the lender’s primary concern is that it generates enough income to cover its debt. That said, DSCR loans are reserved for investment properties that generate income, whether a single-family unit or multi-unit structure.
In the past, lenders have restricted loans to structures of four units or less. But more recently, lenders have granted loans to larger, multi-unit properties.
Specifically, lenders will look at the following:
Additionally, lenders typically expect an LTV of 80% or lower, which means that the loan can’t be any more than 80% of the appraised value. That is why the property must be professionally appraised prior to the approval of the loan.
Pros and Cons of a DSCR Loan
While DSCR loans are a great option for real estate investors, it’s important to weigh the pros and cons whenever you take out a loan. Here are the advantages and disadvantages of DSCR loans.
On the plus side, DSCR loans offer borrowers the following advantages:
- Easier to qualify for compared to conventional loans, requiring no proof of income
- Require less documentation compared to conventional loans
- Faster processing time for loan approval
- No limit on the number of DSCR loans — ideal for multi-property owners
- Jumbo loans available for high-end real estate properties
Lenders also offer flexible loan terms so that borrowers can customize their mortgage payments.
Despite these advantages, there are some drawbacks to DSCR loans. For starters, it’s important to remember that DSCR loans are aimed at investors, which may make them inaccessible to other types of borrowers.
Additional drawbacks include:
- Higher down payment requirements, usually 20% or higher
- Some lenders may have high credit score requirements
- DSCRs are limited to income-generating properties
- Most DSCR loans come with prepayment penalties
Additionally, DSCR loan eligibility assumes that the property has a good DSCR ratio of 1.0 or higher, which may not apply to all properties.
Also, it’s important to remember that your cash flow depends on having tenants occupying your rental property. Vacancies can hinder your cash flow, which may limit your ability to repay your mortgage debt obligations.
How to Get a DSCR Loan
To secure a DSCR loan, you’ll simply need to complete the following steps.
1. Find A DSCR Loan Lender
A DSCR loan is a Non-QM Loan, which are not offered by all mortgage lenders. Be sure to work with a lender that offers these alternative loan types.
2. Complete a Loan Application
Once you settle on a reputable lender, complete the loan application. Most lenders offer an online application for ease of access, or you can contact a loan officer directly to start the process.
3. Calculate Your DSCR Ratio
Using the formula provided above, calculate the DSCR ratio. Your rent schedule will verify the fair market value of the property and prove that you can afford monthly payments on a new mortgage. It will also influence the interest rate that you qualify for.
4. Get Approved and Lock in Your Interest Rate
As long as you and the property meet the lender’s requirements for a DSCR loan, you’ll be approved quickly, which also allows you to lock in an interest rate for the span of your loan.
5. Receive the Loan and Make Repayments
Once approved, you’ll receive the loan. You’ll now need to make monthly payments according to your repayment schedule. For rental property owners, this also means ensuring that your property is occupied with reliable tenants for a continual flow of cash.
Find the Right Mortgage Partner
Real estate investing offers the promise of great gains for the right investor. As long as you keep the property occupied with responsible tenants, you’ll have a reliable income stream that can pay off your loan and generate revenue.
DSCR loans are ideal for investors who might otherwise lack the documentation needed for a conventional mortgage loan.
That’s why it helps to partner with the right mortgage lender that can connect you with the best DSCR loans. The best lenders offer flexible loan terms and low interest rates while working with borrowers to find a program that aligns with their investing goals.
Learn more about non-QM loans, a mortgage option for borrowers with unconventional income or credit. Contact us today to see if a non-QM loan is right for you!
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