Unlike traditional loans, debt service coverage ratio (DSCR) loans are designed for borrowers who want to avoid the income verification standards, slower approvals, and underwriting complexities of conventional mortgages. The DSCR loan pros and cons vary depending on the borrower’s goals, financial situation, and property investment.
Before You Apply for DSCR Loans
If you’re considering applying for a mortgage from a DSCR mortgage program, contact the experts at The Mortgage Shop today. These leading experts will help you throughout the entire process, from understanding the best type of loan for you and getting pre-approved to solidifying the loan terms and amounts perfect for your investment property.
The following article will explain the pros and cons of DSCR loans compared to traditional mortgages, how these loans are processed, and if they might be right for you.
Comparing DSCR Loans to Traditional Mortgages
A debt service coverage ratio loan is a loan that ‘covers’ the debt, which is mostly the principal and interest on the loan. If a rental property has ample cash flow generated, that operating income should cover the debt obligations. A DSCR loan is issued based on the income potential of a rental property, and not based on the borrower’s personal income.
Avoid Personal Income Criteria with a DSCR Loan
By comparison, a conventional mortgage is a non-government mortgage loan that is issued based on the borrower’s personal income, assets, credit history, and other financial benchmarks.
Whereas a DSCR lender is not concerned with personal income verification, a conventional lender will carefully evaluate the borrower’s financial statements, personal funds, and more.
Conventional loans typically come with lower interest rates, but the paperwork is more extensive and the restrictions on rental properties are more invasive.
Why Debt Service Coverage Ratio (DSCR) Loans are Ideal for Real Estate Investors
Real estate investors like to strike when the iron is hot. With DSCR loans, they don’t have to stress paying off certain mortgages on a primary residence or other loans. The DSCR loan allows a rental property investor to start investing right away in rental properties before their purchase prices rise too high.
Every Real Estate Investor Should Consider a DSCR Loan
Oftentimes, rental property investors show minimal income on their personal income statements and tax returns. After all, rental property investors avoid employment income taxes as much as they can. For a traditional loan, this might disqualify them from getting approved. Fortunately, because the DSCR loan doesn’t have personal finance requirements, these limitations do not restrict your capacity to invest.
DSCR lenders are primarily concerned with the cash flow generated, and the investor’s ability to cover debt obligations. If the net operating income is sufficient compared to the debt, DSCR lenders are likely to approve a borrower.
The Main ‘Pros’ of DSCR Loans for Investment Property
There are many DSCR loan pros and cons that real estate investors quickly discover. Most notably, investors pursue DSCR loans for ease of access, the streamlined process, and the lack of income standards. The following advantages of DSCR loans are well known among commercial real estate owners.
No Income Benchmarks for DSCR Loans
DSCR loan underwriters are focused on your rental income, not what you make under your employer. If your income source is complicated or detailed, you don’t need to worry about it. Most DSCR lenders have no reason to check your employer, which means the verification of your property’s earning potential is accelerated.
Just make sure you have the paperwork on your monthly rent and debts to prove that you have sufficient income to make mortgage payments. If you can pay lender-associated costs reliably and predictably, you’re in good shape.
DSCR Loan Flexibility
There may be many DSCR loans good for your situation. Not only can you borrow loans that are independent of your household income, but because your personal finances are separate, you can continue to borrow.
Finance Multiple Investment Properties With a DSCR Loan
In other words, you can take out multiple DSCR loans simultaneously, all approved based on the different properties’ cash flow. Just make sure you don’t end up with negative cash flow!
A DSCR lower than one indicates negative cash flow. Shoot for a DSCR of at least 1.25, meaning you have 25% left over after covering your debts.
Fortunately, many DSCR loans do not appear on reports of personal credit. You can often close on your DSCR mortgage using an LLC entity. This makes a DSCR loan ideal for your rental investment.
Faster Loan Process
You can get the entire loan closed much faster than you could a traditional mortgage. This is mostly due to the time saved by not analyzing income statements and employment history. Because DSCR loans are funded privately, you do not have to wait on slow government processes. In the end, you can get your loan with less hassle, headaches, and time wasted.
The Main ‘Cons’ of DSCR Loans in 2023
If you’re looking to take advantage of commercial loans for investment properties, careful consideration will help ensure you’re making the right choice for your investment. While the benefits of DSCR mortgages are highly touted, there are also downsides to be aware of.
Higher Credit Score Requirements
Conventional residence loans may allow you to have a credit score as low as 580. To qualify for a DSCR mortgage, however, you’ll need to at least have a score of 620, often higher. You can affect this minimum requirement with larger down payments and better debt service coverage ratios. No matter what loan you take out, remember that there are limits. Most lenders of DSCR loans will cut you off at $2 million, so you may have to opt for other commercial loans if you’re looking for a pricier property.
Higher Down Payments and Interest Rates
A DSCR loan borrower will have to produce more money upfront than a traditional loan borrower. Your down payment may have to be 20% or 25%, compared to a minimum of 15% for conventional loans.
In addition to higher down payments, you will also face higher interest payments. Of course, these interest levels can be lowered by the size of your down payment or your coverage ratio. The higher the ratio and down payment amount, the lower your interest rate.
Just don’t forget about lender and service fees, which may be 1% of the full loan value.
Vacancies and Missed Rent
As with any rental property, you have to be wary of situations where vacancies occur, or tenants don’t pay up. You should always consult a local realtor or investment specialist before acquiring investment properties.
You should also ensure substantial cash reserves in case you lose tenants or are unable to collect adequate rent.
Depending on the lender, you may have to show that you have half a year’s worth of mortgage payments in your bank in case tenant and rent issues occur. On the other hand, if you pay off your loan too quickly, you may incur prepayment penalties.
Using DSCR Loans for Your Investment Property in 2023
Now that you have a better idea of DSCR loan pros and cons, it should be easier to decide on the mortgage product right for your goals. Do you have an investment short-term or long-term rental? Do you have substantial net operating income to service your debts? Or are you struggling to have just a little bit of money left over?
Unsure about your employment history and personal financial records? Whether you want low-interest payments, high loan limits, easy credit score minimums, or anything else, you can find it with the right broker.
If you have any questions or concerns at all about the DSCR loan mortgage program, you’re not alone. Give us a call or shoot us a message online and we’ll respond to you as soon as possible. Put your worries aside. Put your investment to work.