The debt-service coverage ratio (DSCR) is a financial metric that measures a company’s ability to meet its debt obligations based on available cash flow. It indicates whether a business generates sufficient income to cover its debt payments, including both principal and interest. The DSCR is calculated by dividing net operating income by total debt service.
A conventional loan typically requires proof of income, such as tax returns or pay stubs. In contrast, DSCR loans allow buyers to qualify for a mortgage based on the cash flow from their rental properties.
Rather than relying on personal income, mortgage lenders use the Debt Service Coverage Ratio (DSCR) to assess a real estate investor's ability to repay the loan. The DSCR ratio helps lenders determine if the rental income generated by the property is sufficient to cover the monthly loan payments.
In addition to the DSCR ratio, investors may need to meet specific credit score requirements or provide a down payment, though these criteria vary by lender.
One significant advantage of DSCR loans is that there is no limit to the number of loans an investor can qualify for. This makes it possible for investors with multiple properties to secure loans for each one, offering a flexible financing solution for both novice and experienced real estate professionals.
While DSCR loans present a strong financing option for real estate investors, it's essential to consider both the advantages and disadvantages before proceeding with a loan. Below are the key pros and cons of DSCR loans.
Pros
DSCR loans offer several benefits for borrowers, including:
Cons
Despite the advantages, there are some drawbacks to consider:
Lenders begin by assessing the borrower’s ability to repay the loan. While specific requirements can vary by lender, most borrowers can expect to meet the following general criteria:
These requirements can differ between lenders, and some may be more flexible with credit history depending on the property.
Furthermore, lenders may adjust the minimum and maximum loan amounts, but note that because DSCR loans are intended for income-generating properties, the range may be more limited compared to conventional mortgage loans.
Property Eligibility
When evaluating the property, the lender’s primary concern is whether it generates sufficient income to cover the debt. As such, DSCR loans are specifically for investment properties that produce income, whether a single-family home or a multi-unit structure.
Historically, lenders have limited loans to properties with four units or fewer, but in recent years, lenders have extended loans to larger, multi-unit properties.
Lenders typically consider the following factors:
In most cases, lenders expect an LTV ratio of 80% or less, meaning the loan cannot exceed 80% of the appraised property value. Therefore, a professional appraisal is required before loan approval.
