DSCR Loan Requirements

Written by Banks Editorial Team
8 min. read
Written by Banks Editorial Team
8 min. read

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Are you searching for a home loan product that doesn’t require tax returns to qualify? This isn’t uncommon if you’re a real estate investor seeking flexible mortgage solutions that don’t come with stringent eligibility criteria, extensive underwriting and drawn-out approvals.

A Debt Service Coverage Ratio (DSCR) loan could be a viable option worth considering. Read on to learn more about how they work and where to find these mortgage products.

What is a Debt Service Coverage Ratio (DSCR) Loan?

A DSCR loan is a mortgage product that caters to real estate investors. It features a streamlined approval process that doesn’t involve traditional income verification. 

Angel Oak Home Loans - Alternative Mortgage Options
Flexible mortgage options for self-employed, real estate investors, and jumbo borrowers. No tax returns required for self-employed. No employment verification for investors.

How DSCR Loans Work

It’s not uncommon for real estate investors to write off a sizable amount of expenses on their tax returns. However, this can be problematic when applying for a traditional mortgage, as lenders generally use the net income of self-employed borrowers. But lenders offering these loan products focus on the DSCR instead of determining your eligibility for a mortgage. If the property generates a sufficient net operating income (NOI) to cover the debt, you can use a DSCR loan to purchase the property. Lenders look at a property’s rental income potential instead of your financial situation.

DSCR Loan Requirements

It may sound odd to hear that a lender won’t ask about your personal income. Lenders won’t even check your personal debt-to-income ratio since it doesn’t matter for profitable real estate investments. As long as rental income exceeds expenses, investors can keep it going indefinitely. DSCR lenders also provide more flexibility. If you want to buy a property with more than 4 units or a non-warrantable condo, you can get the financing you need with a DSCR loan. Investors cannot obtain conventional mortgages for these types of properties. You can accumulate as many properties as you desire as long as you find rentals with favorable DSCRs. 

While DSCR loans can help investors scale their rental property portfolios quickly, lenders won’t simply take your word for it that a property can generate enough cash flow to meet their DSCR minimum. Instead, they will request a signed lease agreement to see the current rental income or a property appraisal if you cannot provide a signed lease agreement. An appraisal increases the lender’s risk, and you may get stuck with a higher interest rate for your mortgage.

You will also need good credit and a high down payment to get a loan. Most lenders will provide financing if you have a 640 credit score, but a higher score entitles you to a lower interest rate. You will also need to put down at least 20% to get a mortgage. Although it’s a good idea to put 20% down for a traditional mortgage, you can get a home with as little as 3% down. DSCR lenders do not provide this option. Finally, you need a loan-to-value ratio (LTV) of 80% or less to get the loan.

Can You Refinance a DSCR Loan?

Want to refinance a DSCR loan? You’re in luck. Borrowers can refinance their DSCR loans at any time. DSCR refinances provide versatility and can help you on your real estate investing journeys. Here are some notable ways to refinance a DSCR mortgage.

  • Cash-Out Refinance: Investors can tap into their equity and get cash out of their loan. Some investors use this strategy to get extra capital to make a down payment on another DSCR loan. You will gradually pay off your loan each month as your rental income exceeds the mortgage and other expenses. Tapping into the built-up equity lets, you gain leverage and add more properties to your portfolio sooner.
  • Get a Lower Interest Rate: The Fed may have lowered interest rates since you got your loan. You could have also improved your credit score during that time with on-time payments for your current loan. Getting a DSCR loan refinance can help you get a lower interest rate and reduce your monthly expenses.
  • Extend the Loan: Adding more years to the backend of the loan reduces your monthly mortgage payments. This strategy increases your monthly cash flow, which can provide a margin of safety and give you more funds for your next down payment.
  • Get Out of Debt Sooner: While this isn’t a popular strategy for rental property investors in growth mode, you can shorten your loan through a refinance to get out of debt sooner. However, shortening the loan will increase your monthly mortgage payments and lower your debt service coverage ratio. A lower DSCR can hurt your chances of getting this type of refinance, but it’s the road less traveled. Investors may have some wiggle room and can contribute to their mortgages with personal income and cash flow from other properties if they want to get out of debt sooner.

Is a DSCR Loan a Good Idea?

A DSCR loan is an unconventional mortgage that provides borrowers with more flexibility. Here are some of the reasons borrowers use DSCR loans to get financing for investment properties. 

  • No personal income requirement: If you do not have enough income to qualify for traditional financing, you can still get a rental property and generate cash flow from your assets. Even if you make good money, your debt-to-income ratio will increase as you take on more loans. 
  • Less paperwork: Since there are no income or DTI requirements, you have to submit less paperwork to get the loan. You don’t have to search for your tax returns, W-2 forms, or 1099s. This can save you a good amount of time and speed up the process of obtaining funds.
  • You don’t get penalized for writing off taxes: Most financial institutions look at your taxable income to determine if you can afford the mortgage. However, real estate investors have many write-offs they use to preserve their wealth. While these strategies keep money in their pockets, each write-off reduces taxable income and makes them appear less desirable to conventional lenders. DSCR lenders ignore your taxable income, so those write-offs won’t hurt your application or result in lower interest rates. 
  • Fewer restrictions: Fannie Mae and Freddie Mac have more limits based on how much capital you can get for a loan, how many mortgages you can have at one time, and other restrictions. You won’t have to worry about those types of restrictions for DSCR loans. As long as you find properties with good DSCR ratios, you can continue acquiring properties and build your real estate portfolio faster.

What Are The Downsides of a DSCR Loan?

A debt service coverage ratio loan has several advantages. However, these mortgage loans are not perfect. Here are some concerns to keep in mind:

  • Higher interest rates: These lenders don’t require any information about your personal income. If you can’t get a tenant on the property, you will have to use your personal income to cover the difference. Lenders increase their risk by not requesting this information, giving them the ability to charge higher rates than Fannie Mae and Freddie Mac. 
  • Higher down payments: Investment property loans help you use leverage to acquire more properties. However, you need to put at least 20% down to acquire the property. Investors may have to put more money down to reduce their debt service coverage ratios. 
  • You can’t use this loan for a flip or primary residence: DSCR lenders won’t let you go through the application process if you want a loan for a flip or primary residence. You have to buy a cash-flow-producing asset. It’s no problem if you want to buy rental properties and hold onto them for several years. However, other investors prefer to flip their way out of a property quickly or start and stop their investing journey with a primary residence. 

You can get very deep into debt: DSCR lenders do not assess a borrower’s ability to make mortgage payments if properties become vacant. Investors with dozens of properties who rely on rental income can be in for a rude awakening if several of their tenants leave the property at the same time. Real estate investors should build large emergency funds with their rental income to mitigate this risk. Investors should figure out how many rental properties they need to hit their goals and then focus on repaying debt before acquiring additional properties.

Do Banks Offer DSCR Loans?

Most DSCR loan programs are available through private lenders, like Angel Oak Home Loans. You can also consult with a mortgage broker to find other options that may be a good fit for you. 

Angel Oak Home Loans - Alternative Mortgage Options
Flexible mortgage options for self-employed, real estate investors, and jumbo borrowers. No tax returns required for self-employed. No employment verification for investors.

What is the Debt Service Coverage Ratio?

The DSCR includes a property’s annual net operating income and mortgage debt (principal and interest). It’s used to gauge cash flow from a property and how much of the income can be allocated towards the monthly loan payment. A higher DSCR helps you qualify for loans and get lower interest rates.

How Do You Calculate the DSCR?

You can calculate the DSCR on a property using this formula: 

Annual Gross Rental Income / Annual Debt Obligations (including principal, interest, homeowners’ insurance, taxes and homeowners’ association fees, if applicable) = DSCR

To illustrate, assume you’re looking to purchase a property that generates an annual gross rental income of $36,000. However, it also comes with $16,000 in annual debt obligations. Based on these figures, your DSCR will be 2.25. So, the property will earn 225% more income than what’s owed on outstanding debt obligations (including the loan and other related costs mentioned above). A 2.25 DSCR is phenomenal and will put you in a great position to receive financing. It would be unfortunate to walk away from a profitable rental property with strong margins because your personal income and DTI aren’t satisfactory for a conventional loan. DSCR loans give borrowers more choices in how they pursue properties.

Why the DSCR is Important

This figure provides insight into the likelihood of the real estate investor repaying the DSCR loan in full. DSCRs at or below 1.0 have a higher probability of default as they indicate the borrower could potentially run into cash flow issues. Lenders want to lower their risk and will reject applicants who may have difficulty repaying the loan. A higher DSCR gives you more leverage in negotiations and can help you secure a lower interest rate.

What is a Good DSCR for a Loan?

Lenders generally like to see a DSCR of 1.25 or higher. If it’s lower, you could still be eligible for a mortgage but will typically receive a higher interest rate and be required to come to the closing table with more reserves. Lenders use these standards to minimize risk. You can lower your DSCR ratio by raising rent, opting for a longer loan term to reduce monthly payments, or with a higher down payment.

What Loans Can You Get If You Have a Low DSCR?

If your DSCR is on the lower end, it will be hard to get a loan. Some lenders will work with you if your DSCR is 1.10, but you won’t get much luck with a DSCR under 1.0. An unfavorable DSCR will result in a quick rejection or a higher interest rate. Here are some other funding options to consider if the DSCR loan doesn’t work out.

Asset-Based Loans 

As the name suggests, asset-based loans are granted based on the number of assets you have at your disposal. Like DSCR, tax returns aren’t required to prove your eligibility for a loan. 

The Asset Qualifier Home Loan from Angel Oak Home Loans, a full-service mortgage lender, could be a viable option for you. Loan amounts of up to $3 million are available. To qualify, you’ll need at least $500,000 in assets post-closing, which could include stock, other investments and funds in a checking account, savings account or retirement account.

This loan product can be used to purchase a new property or to complete a rate-term or cash-out refinance. However, the property must be used as your primary residence. Furthermore, you’re not required to present income or employment information when you apply.

Bank Statement Loans

Bank statement loans are used by borrowers who’d prefer to provide personal or business bank statements in lieu of tax returns to substantiate their income.

Angel Oak Home Loans also features this loan product in its arsenal of mortgage offerings. Designed for self-employed borrowers with at least two years of experience, the Bank Statement Home Loan requires you to provide 12 or 24 months of personal or business bank statements when you apply. Or you can use 1099 income to qualify for a mortgage. 

Your transactions are then analyzed to determine a loan amount that works best for your financial situation. For example, you could be eligible for a Bank Statement Home Loan between $150,000 and $3 million and use it to purchase a primary home, second home or investment property.

Hard Money Loans

While DSCR loans serve rental property investors, hard money loans are better for property flippers. These short-term loans have low down payment requirements and start off with low monthly payments. However, the expenses ramp up after the introductory period expires. Many flippers use this gap to renovate the property and list it on the market. In addition, hard money loans are nonconforming loans which means fewer restrictions and higher loan amounts. 

Explore Additional Mortgage Loans

If none of those options works for your financial needs, you could still be eligible for a mortgage. Another viable option for real estate investors is the Investor Cash Flow Loan. It also allows you to secure a mortgage of up to $1.5 million to purchase an investment property without providing tax returns or complex financial statements. Furthermore, there’s no limit on the number of properties you can purchase, and you’re allowed to place them in your LLC’s name.

You can complete this online form to learn more about other mortgage offerings available through Angel Oak Home Loans.

Angel Oak Home Loans - Alternative Mortgage Options
Flexible mortgage options for self-employed, real estate investors, and jumbo borrowers. No tax returns required for self-employed. No employment verification for investors.

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