How to find the best way to finance rental properties is a question both novice and expert real estate investors are asking themselves constantly. There are a lot of different mortgage loans, and each of them comes with a unique set of pros and cons. Figuring out what are the DSCR loan pros and cons might take some time and can require a lot of research. To save you time on both, we’ve decided to take a closer look at one of the most popular financing options, DSCR mortgage loans, and discuss them in some detail.
What Are DSCR Loans?
Debt service coverage ratio (DSCR) loans are a type of investment property loan. Lenders that offer this type of loan use the DSCR score of a particular property to determine whether or not a borrower can actually repay the loan. This means that, as long as the numbers for a specific property are good, almost anyone can be eligible to get a DSCR loan.
Instead of focusing on the borrower’s personal income or job history, DSCR loan lenders mainly take into account the property’s rental income and use it as a basis to approve or deny a loan application. To calculate DSCR, lenders will usually divide the net operating income (NOI) of a property, with the debt service. The resulting number will allow lenders to determine if a certain property can generate enough income to cover the debt.
For the most part, DSCR loan lenders will be looking for a DSCR score of at least 1, while the ideal score would be 1,25. It’s also important to mention that there are some lenders that will approve a loan even if the DSCR score is below 1, but they will most likely be looking for a larger down payment. On average, the DSCR loan down payment will be in the vicinity of 20-25% of the property’s value (in the case that the score is 1 or above). So, the borrowers that are interested in a property with a DSCR score lower than 1, should expect a down payment to be higher than 25%.
Why Are DSCR Loans Popular With Investors?
Since 2020, there’s been a steady rise in the popularity of DSCR loans across the US. The amount of money invested in the US housing market via DSCR loans, has almost quadrupled in the past couple of years. For example, in 2020, the value of all issued DSCR loans in the US was $4,2 billion. In 2021, that number skyrocketed to $8,3 billion, while in 2022 it reached its peak at around $16,5 billion.
The reasons for the increase in popularity of DSCR loans are many — from being much easier to get than other types of mortgage loans, to the fact that JP Morgan Chase joined the DSCR Loan market in 2022. In addition, one of the main reasons for the popularity of DSCR loans is the increasingly higher cost of conventional mortgage loans (due to a rise in interest rates and the inability of many borrowers to cover down payment costs).
DSCR Loan Pros and Cons
Just like any other type of investor-only loans, DSCR loans come with different pros and cons.
DSCR Loan Pros
DSCR loans are one of the most favorite financing options for investors looking to purchase rental properties. They are highly regarded in the real estate space because they:
- Are more accessible — Apart from the borrower’s credit score, DSCR loan lenders are mostly interested in one thing – the DSCR score of a specific rental property. They don’t take into account the borrower’s personal finances or job history, which makes this type of loan attainable to a wider variety of investors.
- Have an easier approval process — Because there’s far less documentation involved in the application process, DSCR loans usually have a much quicker approval process, when compared to other investor-only loans.
- Come with limitless cash-out — DSCR loans usually come with an unlimited cash-out option. This means that borrowers can keep taking out money in order to finance the costs of regular maintenance, repairs, and similar.
- Allow for an unlimited number of properties — Regular mortgage loans don’t allow borrowers to buy additional properties until the loan is fully repaid. On the other hand, as long as the numbers work, DSCR loans give investors the ability to buy numerous rental properties, at the same time. This makes DSCR loans great for novice and experienced inventors looking to create or improve their portfolios.
- Give investors an option to buy ALL types of rental properties — With DSCR loans, investors can purchase any type of rental property, such as commercial buildings, apartments or apartment buildings, single or multi-family homes, luxury properties, etc…
DSCR Loan Cons
Just like any other type of mortgage loan, DSCR loans come with certain cons. They include things such as:
- A bit higher interest rates — To mitigate the financial risk of DSCR loans, lenders usually opt for increasing interest rates, but not by much. Typically, DSCR interest rates will be 1% higher, when compared to other mortgage loans.
- Larger down payments — For regular mortgage loans, lenders will usually require a down payment between 3-15% (depending on the loan amount, exact type of loan, etc). When it comes to DSCR loans, lenders will generally ask for a down payment of at least 20-25%.
- Restricted loan amounts — The minimum loan amount for DSCR loans is $100,000, while the upper limit is $5,000,000. This means that borrowers who are looking to buy multiple high-end properties might want to look for a different type of loan.
- Exclusively for rental properties — With DSCR loans, borrowers can only purchase rental properties (or properties that generate streams of income). Meaning, they can not be used for buying a main residence, or for purchasing a house in order to flip it.
- Don’t consider vacancies — Vacancies are a normal occurrence when dealing with rentals. But, DSCR loan lenders don’t take them into account. Meaning that, if a property is vacant for an extended period of time, borrowers might have a hard time generating enough cash flow to repay the loan. This can put them closer to defaulting on the loan.
- Fines for prepayment — DSCR loans have strict prepayment penalties and fines (usually between 1-5 years) that borrowers will have to deal with, in the case that they choose to repay their loan early. The exact type of penalties will depend on the specific lender, loan amount, time frame in which the loan was repaid, and similar.
Alternatives to DSCR Loan Pros and Cons
DSCR loans are non-qualified mortgage (non-QM) loans that are solely meant to help borrowers finance rental properties. However, not all people looking to buy a property are interested in DSCR loan pros and cons. And luckily for them, there are some alternatives they could look into. Alternatives such as:
- Asset loans — These types of loans allow borrowers to use their current assets as a guarantee they will repay the loan. Assets could include different types of accounts, such as bank or retirement accounts.
- Angel investor loans — With these loans, investors provide capital in return for equity or convertible debt. In the case of rental property investment, angel investors will own a certain percentage of the property and the monthly income it generates (basically, a portion of the rent).
- Jumbo loans — DSCR loans have a limit of $5,000,000 per borrower. This means that investors looking to purchase high-end expensive properties might need more funds to finance their endeavor. This is where jumbo loans come in. They offer higher loan amounts and come with more flexible loan requirements.
- Commercial real estate loans — These types of loans are specific to each borrower and are meant to help them with their portfolios. They allow borrowers to invest in single or multi-family homes, apartment or commercial buildings, etc.
- Hard money loans — Provided by private lenders, these types of loans put the property the borrower is interested in buying as collateral. They also require less paperwork and have quick closing times but have larger down payments and higher interest rates.
- No-Doc Mortgage Loans — Lenders of this type of loan will only work with borrowers that have a credit score of at least 700. Down payments can be as high as 40%, but the closing times are quick.
What does a DSCR loan mean?
DSCR is an acronym for Debt Service Coverage Ratio. It’s a metric used to determine the borrower’s ability to generate enough cash flow in order to repay a loan.
Can foreigners get DSCR loans?
Yes, nonresidents are eligible to get DSCR, foreign national mortgage loans, and other types of mortgage financing options in the US. Before getting a loan, it is good to be aware of DSCR loan pros and cons.
Is it more difficult to get DSCR loans than other types of loans?
No, it’s usually much easier to qualify for and get a DSCR loan than almost any other type of mortgage financing. To qualify for a DSCR loan, the borrower doesn’t need to show their financial information, W-2 forms, or job history. Getting approved for a DSCR loan mostly relies on the income a specific property can generate (i.e., monthly rent). The borrowers looking to invest in rental properties will have a much easier time getting a DSCR loan than any other type of conventional loan.
Finance Your Rental Property With a DSCR Loan
Are you searching for financing options to invest in a rental property? Now when you are aware of DSRC loan pros and cons – it might be the thing for you! To get a DSCR loan, you won’t need W-2 forms, verifications of your personal income, or other similar things that other types of mortgage loans require. But what you’ll need is some help finding lenders that offer great loan terms.
As a mortgage broker licensed in all 50 states, NRI can assist you in getting the best financing deal for your rental property. Our team of seasoned professionals will analyze your case and connect you with lenders all across the US. We’ll then help you sort through all the loan offers, compare them, and choose the one that maximizes your returns.
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