Unlike a consumer or owner-occupied mortgage loan, but similar to a commercial real estate mortgage, a DSCR loan is underwritten based on property-level cash flow, rather than personal income. DSCR or Debt-Service Coverage ratio is a tool to help lenders understand a borrower's ability to pay back a loan based on the monthly rental income of the property. DSCR is a simplified way to measure cash flow and is calculated by dividing the monthly rent by the monthly principal and interest payments, taxes, insurance, and association dues (PITIA). DSCR ratio is a tool to help lenders understand a borrower's ability to pay back a loan based on the monthly rental income of the property.
For a commercial or multi-family property, DSCR is calculated by dividing the annual Net Operating Income (NOI) by the annual debt service (same thing as the annual PITIA). The formula for commercial property DSCR is:
DSCR = Net Operating Income / Annual Debt Obligations
For example, if a property generates a Net Operating Income of $100,000 annually and its annual debt service is $81,783, the equation would like this:
The annual debt service in this example is less than the Net Operating Income, which makes the monthly cash flow positive.
DSCR loans typically can be used for the following property types:
Single-family (1-4 unit) residential rentals
Vacation or short-term rentals
Commercial or multifamily property
DSCR loans typically cannot be used for the following property types:
Rural properties
Properties with square footage of less than 750 square feet
Condotels
Manufactured housing
Dome homes
Log cabins
Also referred to as investment property loans, Non-QM loans, and rental loans, among other synonyms, DSCR loans have become quite trendy recently. So what is all the buzz about? While it is possible for investors to obtain a conventional loan or funds through a small bank, this financing is tedious to qualify for and has substantial liquid reserve requirements. DSCR Loans, on the other hand, are specifically designed for the professional real estate investor to use cash flow generated by the property as a qualification. Let's take a closer look.
Experienced real estate investors with multiple mortgaged investment properties and self-employed investors without W2's often have difficulty meeting conventional loan criteria. The credit, reserve, and income requirements of conventional loans are strenuous. Further, they are underwritten using Debt-to-Income ratio or DTI, which looks at your personal assets compared to your personal debt. If you are trying to finance the purchase of a rental property with a conventional loan, the payment for the new loan will be included in the debt portion of your debt-to-income calculation. Whether you can offset that new monthly payment with a portion of the expected rent will depend on how well you can document the actual or expected rents from the property.
Investors that have a lot of personal income from non-investment property sources, may be able to cover the “cash flow gap” on their DTI calculation up to some point. Investors that are self-employed or who have multiple mortgaged investment properties may not have income from other sources to cover this gap. Using debt service coverage ratio eliminates DTI from the underwriting and instead focuses on the rental income from the subject property relative to its monthly payments.
Many experienced investors prefer to borrow through an LLC or corporation to protect their identity and other investments. This adds an extra layer of protection to the investor's personal assets for any unfortunate incidents on the property. Conventional loans can only be obtained in an individual(s) name.
Even if an investor has enough personal income to support multiple mortgaged rentals, with traditional loans you are maxed out at ten loans. Most DSCR lenders do not have set limits but instead use common sense when evaluating an investor's maximum credit exposure.
When applying for a conventional mortgage, you have to gather all of your pay stubs, bank and asset statements, and tax documentation, including tax returns. The underwriters are going to dive deep into your personal financial documents and history, which is time consuming and tedious. Any missing documentation or schedules in your tax returns can lead to lengthy delays. Since DSCR lenders focus on the value of the property and the expected cash flow of the property, plus the quality and depth of your credit, there is far less necessary documentationt. Most DSCR lenders will not ask you for documentation to verify your employment, income or assets (beyond required liquid reserves).
DSCR loans have become increasingly popular over the last several years for a variety of reasons. One reason is that capital markets have grown widely comfortable with non-QM loans, including jumbo loans, bank statement loans, foreign national loans, and DSCR loans. According to CoreLogic, the non-QM share of the housing market doubled from 2020 to 2022 and accounted for 4% of the mortgage market in 2022. Also in late 2022, HouseLogic reported that JP Morgan Chase joined the DSCR Loan MBS game further boosting the asset's authority in the market. Another key reason is that the lack of mortgage loan affordability (including soaring interest rates and insufficient down payment funds) and low inventory are driving a trend toward rentership. RCLCO Real Estate Consulting notes that even though they are being outpriced, living in a single-family home is preferable among renters. Millennials are entering prime housing formation years and want to live in homes with yards and multiple bedrooms, as opposed to apartment units. Finally, despite the high interest rates, investors are finding single family rentals highly profitable with higher rental income than debt obligations. In a volatile market, stability is key, and SFR rentals provide stability. DSCR loans are a popular way to finance these properties and are a more seamless experience than other types of investment property loans.
A debt service coverage ratio of 1.2 is solid , and anything above a 1.5 is strong. A DSCR ratio of 1 indicates the rent exactly equals the monthly sum of principal, interest, taxes, insurance, and association dues (if any). With a debt service coverage ratio below a 1, the investor will be subsidizing the PITIA with cash from other sources.
Let's look at some examples for a clearer picture.
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Principal + Interest= $1,800
Taxes= $250
Insurance= $150
Association Dues=$35
Total PITIA= $2235
Rent= $2100
DSCR= Rent/PITIA=2100/2235=0.94
Since the DSCR is .94, we know the PITIA is greater than the monthly rent from the property, indicating negative cash flow.
Principal + Interest= $1,500
Taxes= $350
Insurance= $150
Association Dues=$100
Total PITIA= $2100
Rent= $2100
DSCR= Rent/PITIA=2100/2100=1.0
Since the DSCR is 1.0, we know the mortgage payments and PITIA expenses are equal to the monthly property rent.
Principal + Interest= $1,600
Taxes= $250
Insurance= $150
Association Dues=$35
Total PITIA= $2,035
Rent= $2350
DSCR= Rent/PITIA=2350/2035=1.15
If we divide the rent by PITIA, we get a DSCR of 1.15, which indicates positive cash flow.
At Visio Lending, we have four common use cases of our DSCR Loan product: Cash-Out Refinance, Rate & Term Refinance, Purchase, and Vacation Rental.
Cash-out refinances are our most popular use case. A cash-out refinance is when you replace your mortgage loan with a new loan for a higher loan amount, and the difference in cash is yours. You could also obtain new financing on a property that is not currently pledged on a loan. Our clients use our cash-out refinances to:
Renovate an existing rental
Buy another investment
Finance a flip
A cash-out refinance is when you replace your mortgage loan with a new loan for a higher loan amount, and the difference in cash is yours. You could also obtain new financing on a prop.
A rate & term refinance is when you refinance an existing loan in order to change the interest rates and/or terms of the loan. Commonly, investors will use a hard money loan or a fix and flip loan to purchase and renovate a distressed property. Once the renovations are complete, they will keep the property as a rental and refinance into a DSCR loan for permanent financing.
We also help investors grow their rental portfolios by financing their purchases. Many of our investors use DSCR loans to:
Purchase already rented properties
Purchase rent-ready properties
Unlike other lenders, Visio has been able to make sense of short-term rents and will finance vacation rentals. Our investors often will use our DSCR Loans to:
Cash-out refinance a vacation rental to buy more properties
Refinance an existing vacation rental, so they can get our 30-year terms and great rates
Purchase a new vacation rental as an investment
Simply put, the debt service coverage ratio is a ratio, and it can be manipulated by changing the numbers. Here are ways to improve your DSCR:
One surefire way to improve your DSCR, is to charge more rent for your rental property. An increase in rental income will give you more cash flow to pay your monthly mortgage payments, and therefore improve DSCR.
Lowering your interest rate will lower your monthly mortgage payments and therefore your DSCR. The best ways to guarantee a lower interest rate are to increase your down payment and improve your credit score.
For help optimizing a DSCR ratio, check out our DSCR calculator.
Other key debt obligations in the DSCR formula are taxes and insurance. Be sure to shop insurance providers for the best rates, though never compromise on coverage. You should also fight your property taxes annually to continue to lower your total debt service.
Just like you can optimize the DSCR ratio, there are some factors that could lower your DSCR ratio. DSCR loan lenders usually require a DSCR of 1.2 or more. You may qualify initially for a DSCR mortgage, and then have some numbers come back higher or lower than you were expecting. Knowing about these DSCR surprises upfront can help investors be extra cautious when calculating DSCR to guarantee positive cash flow.
If the cost of insurance you calculated in your initial debt-service coverage ratio comes back higher, your monthly expenses will increase and therefore lower your DSCR ratio, cash flow, and ability to qualify for a DSCR loan.
Similar to an increase in insurance, an increase in property taxes will increase your monthly expenses and, therefore, your debt-service coverage ratio.
Frequently, we see a property being leased for a rent that is higher than market value. When an investor lowers their rent and rental income, the debt-service coverage ratio goes down.
While this is not a surprise that will impact your ability to qualify for a DSCR mortgage, a prepayment penalty is a feature of most DSCR loans that you don't want to be a surprise. A prepayment penalty is a contractual clause that states the borrower is going to pay the lender an additional fee if the borrower pays the loan off early. This isn’t necessarily a “penalty,” however. Here's how it works.
A common prepayment penalty structure — and in fact, Visio’s standard structure — is called a 5/4/3/2/1 structure. This means that if the borrower pays off the loan in year one, they have a 5% prepayment penalty, in year two, a 4% prepayment penalty, and so forth. If your prepayment penalty structure is a 3/0/0, it means that in the first year you pay a 3% fee, and then the penalty goes away after that. The reason the term "penalty" is not accurate is because it does not necessarily impact your DSCR loan. For instance, investors looking to hold onto their properties long-term are not impacted by the prepayment penalty. Investors who want more flexibility can take a higher interest rate to get rid of their prepayment penalty entirely.
For help optimizing a DSCR ratio, check out our DSCR calculator.
So we talked about what could lower or raise your debt-service coverage ratio, but believe it or not this is not the whole picture. Yes, you are looking at net operating income compared to debt obligations, but if you think about it an investor's monthly payments often comprise of more than just PITIA. While DSCR loans require a 1.2, there are more payments that need to be taken into consideration for the full picture of cash flow for any given property.
Many investors give a portion of their rental income to a property manager. This makes managing investment properties much simpler, yet does cut into your overall monthly cash flow. Some lenders will look at property management as part of their debt-service coverage ratio calculation, but this is not always the case.
With a portfolio of investment properties naturally comes general maintenance and repairs. This is not necessarily a monthly expense, however it is still important and can reflect your total debt service for the year. We recommend having savings set aside specifically for this purpose.
"Vacancy" might as well be a curse word for a real estate investor. A vacancy means no rental income to assist with your mortgage payment. Again, we recommend every real estate investor have substantial savings to help them build their real estate portfolio. It also good practice to have Rent Loss Insurance to assist with rental income in the event of a vacancy.
The list of expenses for real estate investors goes on and on. Investment properties need tenants, which means marketing, advertising, screening, and contracting. These are not recurring expenses, yet still they can add up and impact your net operating income annually.
A great thing about DSCR loans is that they don't look at your personal debt or income. However, on your annual tax returns you are going to have to include rental income. Fortunately, there are great tax deductions for landlords.
Our goal in highlighting these prevalent real estate investor costs is to show that a fantastic DSCR ratio does not mean automatic success. It is important to consider a complete picture of your debt obligations before obtaining a DSCR loan. If you think you are ready to apply for a DSCR loan, keep reading for requirements and what to look for in a DSCR lender.
If you are using a DSCR loan to purchase a vacation rental, the DSCR calculation does not take into consideration all of the furniture you have to buy for the property. Not to mention the dishes, bedding, electronics, etc. needed to get a vacation rental property up and running.
Our goal in highlighting these prevalent real estate investor costs is to show that a fantastic DSCR ratio does not mean automatic success. It is important to consider a complete picture of your debt obligations before obtaining a DSCR loan. There are also some scenarios where a DSCR loan will not be a good fit. We'll get into that in the next section and then if you think you are ready to apply for a DSCR loan, we'll discuss the requirements and what to look for in a DSCR lender.
A DSCR loan is a powerful tool for real estate investors looking to build a portfolio of investment properties. However, DSCR loans are not ideal for everyone. Here are some examples of when you would not use a DSCR loan:
DSCR Loans can only be used to purchase an investment property. For your primary residence, you should stick with conventional mortgages.
Many real estate investors are able to obtain conventional mortgages on their first investment property. The interest rates will be lower and first time investors often have the income and documentation needed to meet the debt-to-income ratio qualifications for conventional mortgages. However, conventional mortgages can only be financed in your personal name. If real estate investors want to protect their personal assets, sometimes they will obtain a DSCR loan for their first investment property so they can finance through an LLC.
Most DSCR loans require rent-ready rental properties. That means no construction projects or anything more than minor wear and tear. Many real estate investors looking to flip an investment property will finance their construction through a hard money loan program and then refinance into a DSCR loan for permanent financing.
If you are purchasing an investment property in a hot market where the rents have not caught up to the home prices, you will not be able to cover the monthly debt payments with rental income. Most lenders require at least a 1.2 DSCR and will not loan to you if you are unable to meet the monthly debt payments. However some lenders, like Visio, have a No DSCR Loan Program for this reason. We see the value in investing in hot markets, and will offer you a No DSCR Loan if you have a strong credit report and meet other qualifications.
Most lenders have a minimum loan amount of $75k and a minimum investment property value of $150k. Even if the rental income will cover the monthly mortgage payments, you likely will not qualify for a DSCR loan. If you don't meet the other minimum requirements. One way real estate investors pay for this kind of property is to use a DSCR loan to pull cash out of another investment property.
For help optimizing a DSCR ratio, check out our DSCR calculator.
If you are an investor and looking to obtain a DSCR mortgage, make sure you meet these basic requirements:
Minimum Credit Score Required: Most DSCR lenders require a 680 credit score with better rates for higher credit. Most lenders also have minimum tradeline requirements, including both amount and duration. Lenders also will consider whether you have any other significant credit events on your credit report, such as foreclosures, bankruptcies or past due payments.
Minimum Down Payment or Equity: Maximum loan-to-value on purchase loans typically is 70%-80% and on refinances is 65%-75% depending on property type, credit and DSCR.
Minimum Property Value: Most lenders have a minimum property value of $150k.
When comparing DSCR lenders, here are some considerations.
It is important to know exactly what your costs will be for the loan. The last thing you want is to end up at the closing table with unexpected costs. Most lenders charge an origination fee and one or more administrative fee (underwriting fee, documentation fee). Also be on the lookout for a prepayment penalty if you are looking to sell the property in the near future.
This may seem obvious, but it does vary between lenders. For instance, some lenders have DSCR Loan Programs for vacation rentals and others do not. Other common variations include warrantable vs. non-warrantable condos and multi-family vs. single-family homes.
In our opinion, this is the most important consideration. Lenders who work with investors often understand the nuances associated with financing and have programs tailored to help investor needs. There are a lot of new DSCR lenders on the market. Here are some things you can look for to help hone in on the most experienced lenders:
Ask about the number of DSCR loans they have closed
Ask how long they’ve been offering and closing DSCR loans
Ask whether they have a dedicated team of operations personnel that process and underwrite their DSCR loans
Ask about their property insurance requirements, because they typically are materially different for investment properties as compared to owner-occupied properties
Ask about their prepayment penalty or rate buy-down options. DSCR loans almost always have a prepayment penalty
Ask about the ability to finance in an LLC or corporate entity
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DSCR loans are an option that have grown in popularity recently due to their use of rental income rather than debt-to-income ratio to evaluate whether you qualify or not.
They are easier to qualify for than an agency or bank loan and have lower interest rates than hard money loans for financing an investment property. However, there are also drawbacks that should be considered when it comes to this type of loan program.
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DSCR loans often have faster application and closing times without the need to submit personal financing documents or tax returns.
There’s also more flexibility on the number of loans or properties, so scaling your business can be done more quickly if you can afford it.
Protect your personal assets by financing a DSCR loan through an entity or LLC.
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Typically, they require a higher down payment (often 15-25% of the property's value).
Interest rates and lender fees are also higher for a DSCR mortgage than a second home loan.
You’ll need to provide proof of experience in renting (either STR or LTR)).
As an example, personal income history is not a consideration when underwriting DSCR loans.
For a DSCR loan, an evaluation is needed of comparable rents in the area is needed in addition to the standard property appraisal report.
Often a real estate investor finances properties in an entity, which in itself has some lending nuances. For instance, there are necessary entity documents.
This is just a sampling of the many nuances associated with a DSCR mortgage. Visio Lending has over a decade in mastering this niche market with over $2.5 billion in DSCR Loans originated, including over $750 million in vacation rentals.
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Low documentation; no personal DTI, no tax returns;
Full 30-year terms with no balloons; and
The ability to protect your identity by financing through a corporate entity
Common sense underwriting of your short-term rents
We finance DSCR loans in 38 states and Washington D.C.: Alabama, Arkansas, Arizona, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Iowa, Illinois, Indiana, Kansas, Kentucky, Louisiana, Massachusetts, Maryland, Maine, Michigan, Missouri, Mississippi, Montana, North Carolina, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington, Wisconsin, West Virginia, and Wyoming
Visio Lending is the nation's premier lender for buy and hold investors offering, long-term loans for SFR and commercial rental properties, including vacation rentals.