DSCR loan math

A Deep Dive Into Debt-Service Coverage Ratio (DSCR) Loans

Investing in rental properties has long been considered a sound investment — and that sentiment continues to hold true as tenant demand, occupancy levels, rental income growth, and property values soar. The current white-hot rental market is spurring serious real estate investors to scale their rental portfolios. 

But finding properties to add to your portfolio is just the first step. Accessing flexible financing and a dependable lender to help grow your business is integral. Without that, it can be difficult to close on a great rental property deal quickly. 

In real estate investing, timing is everything, and a hot seller’s market requires quick approvals. Many restrictions of traditional funding avenues are loosened when targeted, goal-focused rental investment debt-service coverage ratio (DSCR) loans are used, making them a popular option for eager investors. Let’s take a deeper look at this non-traditional long-term financing option.

What is a DSCR Loan?

A DSCR loan, also known as a rental investment loan or rental loan, is a type of hard money, no-income loan originated based on the property’s projected cash flow (as opposed to the borrower’s income, like with a typical mortgage). 

DSCR loans provide long-term financing for a buy-and-hold, or rental, investment strategy. Like a traditional mortgage, they require a down payment and a decent credit score and charge annual interest.

How Does a DSCR Loan Work?

Extensive income verification is required with a conventional mortgage, whereas DSCR loans use the property’s cash flow during underwriting to determine a borrower’s eligibility. Borrowers don’t need to provide tax returns or pay stubs or prove their income to qualify for a loan, resulting in faster and easier access to capital. Because you avoid the lengthy income verification process, this loan option allows for a quicker, more simplified financing process.

Qualification and Eligibility

When qualifying for a DSCR loan, the lender considers several factors, including the borrower’s credit score, available down payment, and the debt-service coverage ratio of the property. Typically, the credit score dictates the interest rate, and leverage is determined by credit score and DSCR combined. DSCR measures the asset’s ability to pay the property’s mortgage and expenses — so, the higher it is, the more leverage the investor can get. 

While your credit score is a factor in determining the leverage and interest rate of DSCR loans, some lenders will only do a soft credit pull. Unlike hard credit pulls, a soft pull won’t affect your score.

What is the Debt to Service Coverage Ratio?

The DSCR is the ratio of operating income to debt obligations. It is a popular benchmark to measure a borrower’s ability to produce enough cash to cover their debt. Lenders use the DSCR to measure and determine the maximum loan amount when a real estate investor applies for a new loan or refinances an existing one.

DSCR is the ratio of income generated for every $1 owed to the lender. The higher the DSCR ratio is, the more net operating income is available to service the debt. For example, a 1.25x DSCR reflects that the asset generates $1.25 for every $1 owed. 

The lower the DSCR, the greater the risk is that the borrower may have to go out of pocket to pay the loan if the property sits vacant for an extended time or the operating expenses turn out to be higher than expected. 

How is DSCR Calculated?

To find your debt to service coverage ratio, divide the sum of your net operating income (NOI) by the total debt service. Each lender will likely have a slightly different method of calculating the above two numbers, so it’s best to inquire about exact numbers with your lender. 

Simply put, NOI is calculated as the property’s annual rental income subtracted by the cost of operations. The resulting number is divided by the sum of your principal, interest, taxes, insurance, and HOA fees (if applicable). The resulting ratio is your DSCR.

Considering a DSCR loan

What is a Good DSCR?

Lenders often consider a “good” DSCR to be 1.25 or higher because it shows that the property generates 25% more profit than expenses and has a positive cash flow as long as it stays occupied. 

If your DCSR is not at least 1.0, your rental income is less than your total debt service, which means you would lose money every month. In that case, it would probably be best to avoid that specific deal.

Typical DSCR Loan Options

Most hard money lenders offer fixed-rate, adjustable-rate, or interest-only options on a DSCR loan. This allows you to choose the terms that work best for your property deal. 

Additionally, several long-term or short-term rental property types are eligible for a DSCR loan, often including: 

  • Single-family rentals (SFRs)
  • 2-4 unit rental properties
  • Attached and detached planned urban developments (PUDs)

Ineligible real estate typically includes: 

  • Mobile homes 
  • Vacant land
  • Log homes 
  • Houseboats

Pro Tip:

Looking to build a new property instead? You'll likely use a construction loan rather than a DSCR loan.

Pros and Cons of a DSCR Loan

Is a DSCR loan the right fit for your rental investment portfolio? Let’s examine the advantages and disadvantages of a DSCR loan.

Pros

  • Increased Accessibility: Because lenders don’t consider your personal income, DSCR loans are much more accessible —even if you don’t have a large amount of liquid capital. 
  • Greater Investment Protection: Since DSCR loans allow you to borrow on an LLC or business entity, you can further protect your personal assets and other investments.
  • Quicker Closings: By cutting out income verification, the application process is simple and straightforward, allowing you to close deals quickly.
  • Scale Faster: With a traditional mortgage, you can only commit to one property at a time. With a DSCR loan, you can take out different loans for different properties simultaneously. Plus, you have the ability to refinance with a cash-out option to purchase your next property.

Cons

  • Specific Loan Qualifications: Qualifications are weighted toward a good DSCR ratio to get the highest leverage and best rates and terms.
  • Higher Interest Rates and Down Payment: Typically, interest rates are higher and a larger down payment is required on a DSCR loan than a conventional mortgage.

Final Thoughts

While there are several lending options available to landlords looking to scale their rental portfolios, a DSCR loan is particularly popular. This loan type allows for the flexibility, ease, and timeliness that successful investors are looking for to finance their deals. 

That’s why it’s vital to find a reliable lending partner you can trust to help you navigate your options and secure the funding you need to grow your rental business. 

Ready to access reliable, fast, and easy financing? Get started with Kiavi today. 

DISCLAIMER: The above is provided as a convenience and for informational purposes only; it does not constitute an endorsement or an approval by Kiavi of any of the products, services or opinions of the corporation or organization or individual. The information provided does not, and is not intended to, constitute legal, tax, or investment advice. Kiavi bears no responsibility for the accuracy, legality, or content of any external content sources.

Kiavi Funding, Inc. 

575 Market Street, Suite 1600, San Francisco, CA 94105

NMLS ID 1125207 – nmlsconsumeraccess.org & Equal Housing Lender

AZ Mortgage Banker License 0926504

CA Finance Lender licensed by CA Department of Financial Protection and Innovation

Toll Free : 844-415-4663

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