Debt-Service Coverage Ratio (DSCR) loans let real estate investors qualify for funding based on their property’s cash flow. That differs from conventional loans, which typically rely on debt-to-income ratios.
This distinct lending approach opens new opportunities for savvy investors. With a DSCR loan, you can scale your real estate portfolio faster without being constrained by the income reported on your tax return.
In this comprehensive guide for real estate investors, we cover everything investors need to know about applying for DSCR loans. You’ll learn about eligibility criteria and property options, and find the details you need to decide whether this funding vehicle aligns with your financial goals.
Let’s get into it.
Table of Contents
What Is a DSCR Loan Program? Understanding The Basics
DSCR loans are based on a financial metric with the same name. To understand how these loans work, you first need to know what a debt service coverage ratio is and how it can impact your ability to qualify for this type of funding.
What Is Debt Service Coverage Ratio (DSCR)?
Debt Service Coverage Ratio (DSCR) is a financial metric used by real estate investors and lenders. It looks at whether your property generates enough income to cover its debt obligations. If yours does, you can generally qualify for a DSCR loan.
The formula for calculating DSCR is simple:
DSCR = Net Operating Income / Total Debt Service
If you run that calculation and get a result above one, that means your property generates enough income to meet its debt payments. For example, you may have $100,000 in operating income and $50,000 in total debt service annually. That equals a DSCR of two, which is another way of saying your property makes twice as much as the debt you accrued to own it.
Why DSCR Matters in Real Estate Investing
Lenders consider DSCR when deciding whether to provide the funding you request. It’s a fundamental aspect of property investment that signals the amount of risk associated with a potential loan.
That makes DSCR worth considering when deciding whether to purchase a new investment property. If you calculate a DSCR above one, it means you’ll have positive cash flow and the potential to borrow additional money based on that.
You can use DSCR to decide between different investment opportunities. Properties with positive cash flow leave you with more flexibility to finance upgrades and other real estate purchases.
Residential vs. Commercial DSCR Real Estate Loans
If you have a positive DSCR, it rarely matters which type of property you own. You could have a residential community with multiple tenants or a commercial property with a single business. Either way, your positive cash flow gives banks a clear justification for lending you money.
The only thing to note is that some lenders have their own property requirements for DSCR loans. For example, your current bank may only offer these deals to investors with single and multi-family units. This means you may need to shop around to find a lender that offers a DSCR loan for the type of property you own — even if you have a positive cash flow.
How To Calculate DSCR Loans
The DSCR formula only looks at two financial metrics. But each of those requires some initial calculations. You’ll learn how to complete those calculations and interpret the results below.
Calculating Net Operating Income (NOI)
First, you need to know your net operating income. To do that, consider the total amount of rental income you get annually. Then, subtract all operating expenses from the figure, including:
- Maintenance costs
- Property management fees
- Property taxes
- Insurance
Your rental income, minus these expenses, equals your net operating income. Calculating NOI offers a clear view of a property’s financial health.
Calculating Debt Service
Next, calculate the annual debt payments that you make on the property. This includes your mortgage payment, interest, and any other fees associated with the investment units. Add all of those costs together, and you’ll have the second half of the DSCR formula.
With up-to-date NOI and debt service figures, you can calculate your DSCR. As detailed above, simply divide NOI by debt service to find your DSCR ratio.
Interpreting DSCR Values
Your DSCR ratio is a reflection of the property’s financial resilience. When it’s above one, your annual earnings are outpacing the debt you pay to generate them. The higher your DSCR, the safer the investment — both for you and the bank you hope to borrow money from.
DSCR vs. Conventional Loans for Investors
Real estate investors use both DSCR and conventional loans to reach their financial goals. But each funding option has its own pros and cons. The option that’s best for you will depend on how you value these.
Generally, real estate investors choose 30-year DSCR loans over conventional loans for these reasons:
- Income Focus: DSCR loans assess a property’s income potential rather than the borrower’s credit, making them suitable for income-generating properties.
- Easier Qualification: They are often easier to qualify for, as they prioritize property cash flow over the borrower’s financial status.
- Higher LTV Ratios: DSCR loans often allow higher loan-to-value ratios
- Favorable Terms: Competitive interest rates and terms are available based on the property’s performance.
- Flexibility: DSCR loans can be used for various residential and commercial property types, allowing for portfolio diversification.
- Faster Scaling: They enable investors to scale their real estate portfolios faster by allowing them to qualify for funding based on property income rather than personal income.
That being said, conventional loans can sometimes offer better interest rates and may require less of a down payment when buying a new property. You may want to review both options with a lender to see how your personal financial factors impact these considerations.
| Feature | DSCR Loans | Conventional Loans |
| Primary Advantage | Property-based qualification and flexibility | Potentially lower interest rates and down payment |
| Primary Limitation | Potentially higher interest rates or down payment | Income-based approval criteria |
| Qualification Speed | Typically fast | Typically slow |
Factors Affecting DSCR Eligibility
If you’re interested in a DSCR loan, the following factors will impact your eligibility. You can take steps to optimize each of these to increase your chances of obtaining a DSCR loan with favorable terms.
Rental Income and Cash Flow
First, you want to maximize the income that your property generates. That means setting competitive rental rates and minimizing vacancies through effective marketing and tenant management. You’ll need a consistent cash flow to support a healthy DSCR.
Operating Expenses
The other half of the DSCR equation is operating expenses. These eat into your net profits and reduce the maximum loan amount you can qualify for. You can reduce operating expenses by:
- Streamlining property management processes
- Reducing insurance costs with bundled policies or improved security
- Controlling maintenance and repair costs
- Reducing utility costs with energy-efficient appliances and smart thermostats
- Finding more cost-efficient marketing strategies
Interest Rates and Loan Terms
Your property’s interest rate and the terms of its loan can also impact DSCR eligibility. Higher rates increase debt costs, which can reduce your property’s ability to maintain a healthy DCR.
That means it’s worth shopping around a bit to find the best deal. Choosing appropriate loan terms, such as fixed or variable rates, can significantly influence your investment’s financial outlook.
Document Requirements for a DSCR Loan
DSCR loan requirements are generally lighter than those of conventional loans. That’s one reason real estate investors love them. However, you’ll still want to have the following documents ready to ensure a speedy approval timeline:
- Leases: Resident leases prove that your property consistently generates the amount of income you said it does in your application.
- Bank Statements: Lenders ask for bank statements to verify that you can cover DSCR loan payments in the event of vacancies and other unforeseen issues.
- Short-Term Rental Proof: You may use a property for short-term rentals, like Airbnb, instead of long-term leases. If so, you’ll need to provide proof of that income.
- Insurance: Lenders will want to see your property insurance policy to verify that the building is covered financially in an unforeseen disaster.
- Business Entity Paperwork: If you own the property through a business entity like an LLC, you’ll need to provide paperwork like a certificate of good standing and certification of formation.
The lender will also create documentation on their end as part of the application process. For example, they’ll run your credit and background reports and verify that you have title insurance.
Another major part of the process is getting your property appraised by a third-party expert. This is something the lender typically handles, but you should be aware that it’s a requirement.
Can You Prepay DSCR Loans?
Yes, you can prepay your DSCR loan if you choose a lending agreement that supports this. Dominion Financial Group offers flexible prepayment structures that can be customized to suit your unique borrowing needs:
- Variety of Options: Borrowers can choose from a range of prepayment penalty options, including zero prepayment penalties and structured plans.
- Tailored to Your Goals: You can choose the prepayment penalty plan to ensure it aligns with your long-term vision and financial objectives.
- Popular Choice: Many clients find the 3-2-1 option to be a preferred choice, which offers a specific prepayment structure.
- For Optimal Rates: If you’re seeking optimal rates, the 5-4-3-2-1 structure may be worth considering.
These prepayment penalty options provide clarity and simplicity. If you need assistance or have questions, don’t hesitate to contact our team for DSCR guidance.
Do DSCR Loans Have Fixed or Variable Interest Rates?
DSCR borrowers typically get to choose between fixed and variable interest rates. The better option for you may depend on the current rate environment.
For example, when interest rates are very high, you don’t necessarily want to lock in a 30-year loan at the market rate. Choosing a variable-rate product instead could help you save money, as your rate should go down as the market rate returns to its historical average.
Fixed-rate DSCR loans are better in low-rate environments. They’re also good if you’re happy with your offer and want to lock it in long-term. Just remember, you also have the option of refinancing your loan and changing the type of interest you’re paying a few years down the road.
How To Get the Best Rate: DSCR Loans Explained
Whether you prefer fixed or variable interest, you definitely want the lowest rates possible. There are some steps you can take before applying for a DSCR loan that can help you do that.
The key thing to note here is that lenders look at three requirements when deciding the terms of your loan:
- The property’s debt service coverage ratio
- Loan-to-value ratio (i.e., will the property generate enough income to outpace debt?)
- Your FICO credit score
Of these, your credit score is the easiest to improve quickly. Paying off an old debt or resolving past-due bills could help you instantly qualify for a lower rate and better terms.
How To Apply for DSCR Loans
DSCR loans are generally much easier to apply for than their conventional counterparts. Here’s what you need to know about the process.
Initial Qualification Check
Traditional loans rely on personal income. This means the application process requires extensive financial documentation. As a real estate investor, you may already be familiar with how frustrating and time-consuming that process can be.
DSCR rental loans use an alternative approach focused on the property’s cash flow potential. This means you’re providing documents related to the property’s ability to generate positive cash flow — not your personal financial status.
So, you can qualify for a DSCR loan even if your personal income doesn’t meet the stringent requirements of traditional mortgage applications. As long as your property generates positive cash flow, you should have DSCR options available to pursue.
Property Cash Flow Assessment
One key part of your application process is the property cash flow assessment. This is where your lender analyzes the net operating income of your property and compares it to the anticipated debt service.
At this point, they want to know if the property’s anticipated cash flow will be enough to outpace your requested debt burden. They’ll also consider factors like your credit score during the application, but that will mostly impact your interest rate and down payment requirements.
Partnering With Specialized Lenders
If you’re going to choose a DSCR loan, it’s worth partnering with a lender who specializes in the financial vehicle. You want a partner that understands the unique needs of this class of real estate investors and has the expertise to evaluate the income-generating potential of investment properties.
That’s what Dominion Financial Services offers. We’re a reputable private lender that specializes in 30-year DSCR loans, among other options. You can count on us to get you through the application process quickly and painlessly so you can access the funding you need to build your portfolio faster.
As you consider low-documentation DSCR loans, it’s important to collaborate with lenders who specialize in this lending approach. Dominion Financial Services is equipped to guide you through the loan application process and assess your property’s potential to secure the financing you need for your real estate investments.
DSCR Frequently Asked Questions
What’s the difference between a DSCR loan and a conventional loan?
DSCR loans are based on borrower credit and property cash flow — not the borrower’s personal income. This gives DSCR loans a low documentation requirement compared to conventional real estate loans.
Conventional loans tend to be harder to qualify for because they look at personal income. There are strict requirements you’ll need to follow in order to meet the criteria of Fannie Mae and Freddie Mac.
However, conventional loans can be an appealing option to those who qualify. They sometimes offer lower interest rates and down payment requirements.
What’s the minimum credit score for a DSCR loan?
Each DSCR lender sets their own minimum credit for this type of loan. At Dominion Financial Group, we require a minimum FICO score of 640. The higher your score, the better the interest rate you qualify for, generally.
What is the maximum LTV on a DSCR loan?
The maximum LTV for a DSCR loan is typically 75%. However, that can vary based on the property’s location, your creditworthiness, and the property’s debt service coverage ratio.
Are DSCR loans available for short-term rentals?
Yes, we offer DSCR loans for short-term rentals at Dominion Financial Group. Eligibility for these properties can vary on a lender-by-lender basis.
Can you get a DSCR loan on multifamily properties with 5+ units?
Yes, it’s possible to get a DSCR loan on multifamily properties with five or more units. Dominion Financial Group specializes in single and multifamily properties up to four units. But we can offer loans for larger buildings, providing you meet our eligibility criteria.
What’s the seasoning period for a cash-out refinance on a DSCR loan?
Dominion Financial Group has a six-month seasoning period. Before that, we can refinance the lessor of 85% of the total cost or 75% of LTV. After six months, there are no loan-to-cost (LTC) restrictions.
Does Dominion offer DSCR financing on commercial properties?
No, Dominion only offers DSCR financing on non-owner-occupied residential properties.
What are the required documents and steps for obtaining a DSCR loan?
Getting your DSCR (Debt-Service Coverage Ratio) loan is a straightforward process that requires several documents and steps:
- Short Application: The application process is quick and uncomplicated, typically involving filling out a simple one-page form.
- Proof of Insurance: You will need to provide proof of insurance to ensure that your property is adequately protected against potential risks.
- Executed Lease Agreement: This document confirms that your property is generating income through rental agreements.
- Purchase Settlement Statement: Providing details about the acquisition of your property, this statement is essential to the loan application.
- Driver’s License, Passport, or Green Card: You must present a valid form of identification, such as a driver’s license, passport, or green card, for verification purposes.
- Two Months Bank Statements: These statements offer a glimpse into your financial health, demonstrating your ability to handle the loan.
- Entity Documents & W9: If you are applying for the loan as a business entity, you will need to provide essential entity documents and a completed W9 form.
Get these documents ready before contacting us, and we’ll be able to approve your loan as quickly as possible. Or, reach out if you have questions.
What prepayment penalty options are available for DSCR loans, and how can they be tailored to borrowers’ goals?
DSCR Loan Prepayment Penalties (PPP) offer flexible prepayment structures that can be customized to suit borrowers’ needs. Here’s what you should know:
- Variety of Options: Borrowers can choose from a range of prepayment penalty options, including zero prepayment penalties and structured plans.
- Tailored to Your Goals: The choice of prepayment penalty plan can be influenced by your long-term vision and financial objectives, ensuring it aligns with your specific goals.
- Popular Choice: Many clients find the 3-2-1 option to be a preferred choice, which offers a specific prepayment structure.
- For Optimal Rates: If you’re seeking optimal rates, the 5-4-3-2-1 structure may be worth considering.
These prepayment penalty options provide clarity and simplicity. If you need assistance or have questions, don’t hesitate to contact our team for guidance.
