What is a DSCR Loan for a Real Estate Investor?

A DSCR loan is perfect for the real estate investor who wants to grow his or her portfolio of investment properties. It is based on the rental income of the property and not the personal income/assets of the borrower. Short for Debt-Service Coverage Ratio, a DSCR loan is perfect for investors who want to scale up their real estate investing business. Usually held in a business entity such as an LLC, the DSCR loan will not count against the personal debt (DTI) ratios of the borrower. Also, even though there is a personal guarantee normally given on the DSCR loan, it will not report to personal credit so long as the loan is paid and maintained in good standing.

How Does a Borrower Qualify for a DSCR Loan?

A DSCR loan is based on the economic characteristics of the property. The rental property cash flow is used to determine the income of the property. Meanwhile, expenses like principal and interest payments, property taxes, and insurance are added up to determine the expenses of the property. A good debt service coverage ratio (DSCR ratio) is 1.20 and above, meaning the net operating income is at least 20% greater than the expenses. In other words, the property generates sufficient cash flow to cover the expenses of the property.

Other than personal credit score, the financial profile of the borrower (borrower’s ability to repay) is not considered for a DSCR loan program. Therefore, a DSCR loan is different than a typical mortgage loan for a personal residence (no rental income in that case). The personal income, employment documents or tax returns, DTI ratios, assets, etc are not normally considered by a DSCR lender (unlike traditional loans from banks).

The minimum loan amount for a DSCR loan is generally $75,000 on a minimum property appraisal value of $100,000. A DSCR loan can be used for a purchase of a rental property, or a refinance of an investment property already owned by the borrower with a good amount of equity.  Interest rates on a DSCR loan may be slightly higher than a conventional loan on a personal residence, but it’s definitely worth it because of the easier application at a DSCR lender and the ability to scale to purchase an investment property over and over.

One drawback is that DSCR loans typically have a pre-payment penalty associated with them. This means that loan repayment (from a refinance or a sale) within 3-5 years may incur a penalty on the outstanding balance. It’s best to take a DSCR loan if the borrower does plan to hold the rental property for a few years.

DSCR loans with a debt service coverage ratio below 1.2 are possible, but may incur a higher interest rate due to the higher risk to underwrite such a DSCR loan with a less positive cash flow.

DSCR loans are not suitable for rehab projects, only properties with rental income currently generated by the property with a positive cash flow that can service the loan. A lender will never approve a DSCR loan for a vacant property in need of renovation (i.e. no rental income generated to meet the annual debt service.