Getting a DSCR loan can be a great way to fund a rental property purchase—especially if you’ve exhausted your other financing options.
Unlike traditional mortgages, DSCR loans don’t require you to qualify based on your personal income. Instead, you qualify based on the property’s income, i.e. its ability to cover the monthly mortgage payments with its cash flow.
By partnering with a reputable DSCR lender like ABL, you can close on properties and grow your rental portfolio faster than you could otherwise.
What Is a DSCR Loan?
A DSCR loan is a real estate investment loan designed for rental properties. It gets its name from the debt-service coverage ratio (DSCR), the main metric by which borrowers qualify.
Basically, DSCR describes how well a property’s net operating income (NOI) can cover its total debt service by dividing the former by the latter. Here’s the formula:
DSCR = Net Operating Income (NOI) / Total Debt Service
Where:
- NOI is rental income minus operating expenses
- Total Debt Service is loan payments (principal, interest, taxes, and insurance)
For example, a rental property with a monthly NOI of $1,000 and an $800 monthly mortgage payment would have a DSCR of 1.25 ($1,000 / $800).
The higher the DSCR, the more easily the property can cover its debt obligations and the less risk it presents to the lender. Meanwhile, a 1.0 DSCR indicates the rental generates just enough to cover its debt service, and anything less than 1.0 means it can’t cover its debt service.
As a result, many lenders set a minimum DSCR, below which they are unwilling to lend.
DSCR Loan Requirements
Here’s a list of common DSCR loan requirements:
Debt-Service Coverage Ratio
Lenders typically require a DSCR of 1.25 or higher. However, ABL has an average DSCR requirement of 1.2 and offers some programs with even lower DSCR minimums.
Credit Score
While not the most important factor, your credit score can work for or against you as a borrower. Most lenders (including ABL) require a credit score of at least 660.
Loan-to-Value (LTV)
Loan-to-value (LTV) compares the amount you borrow to the property’s value by dividing the former by the latter. For example, a $400,000 loan on a $500,000 house has an LTV of 80% ($400,000 / $500,000). It’s the inverse of the down payment (in this case $100,000 or 20%).
As with any mortgage, DSCR loans have a maximum LTV (or minimum down payment) requirement. At ABL, we offer DSCR loans with LTVs of up to 80%.
Appraisal
To determine a property’s market value (and thereby LTV), lenders often require a professional appraisal. Typically, this expense is rolled into your closing costs.
Loan Amount
Many DSCR lenders set minimum and maximum loan sizes. For example, ABL offers DSCR rental loans of $100,000 to $3 million.
Property Type and Use
DSCR loans are only available for properties that generate regular rental income. These could be single-family rentals, multifamily properties, or even commercial buildings.
At ABL, we offer DSCR loans for all of the following:
- 1-4 unit residential buildings (single-family homes, duplexes, triplexes, and fourplexes)
- Townhomes and condos
- 5-8 unit multifamily properties
In addition, we offer DSCR financing for short-term rentals (STR), i.e. properties rented out for days (not months) at a time to travelers via STR platforms like Airbnb and VRBO.
Experience Level
Some DSCR lenders require borrowers to have a certain level of experience, or they may at least adjust loan terms based on your experience and perceived risk.
ABL works with investors of all experience levels, from beginners to seasoned pros. No matter where you are on your investing journey, we’re here to help your project succeed.
DSCR Loan Terms
Once you’ve met a DSCR lender’s loan requirements, you must agree on these loan terms:
Loan Term
Loan term is how long you have to fully repay the loan. This could be 15, 20, or 30 years, though 30 years is most common for DSCR loans.
Loan Structure
How you pay off the loan (aka amortization) can be structured in many ways.
Most DSCR loans are amortized gradually with fixed payments. However, lenders like ABL also offer alternatives—such as 5/1, 7/1, 10/1, and interest-only options—in which loan payments are fixed for an initial period and vary thereafter due to an adjustable interest rate or the deferral of principal costs.
Interest Rate
Of course, you must agree to an interest rate for your DSCR loan. This is typically set by the lender based on market rates, your loan application, and other economic factors.
Origination Fees
DSCR lenders charge origination fees (aka points) to cover application, underwriting, and other administrative costs. These fees are expressed as a percentage of the loan amount, e.g. 1-2%.
Prepayment Penalty
Many DSCR lenders charge a penalty fee if you pay off your loan early. Though you may not plan to, it’s an important loan term to be aware of.
At ABL, we don’t impose a pre-payment penalty on any of our loan programs.
How to Get a DSCR Loan
Now that you know what DSCR loan requirements and terms to expect, here’s how to get one:
1. Find and Compare Lenders
Look for reputable DSCR lenders in your market. Check their online reviews and ask about their DSCR loan requirements and terms.
2. Get Pre-Approved
After choosing a lender, pre-qualify for a DSCR loan by providing some basic details about you and the property (address, price, rent, etc.).
3. Apply for a DSCR Loan
Once pre-approved, apply for a DSCR loan by supplying the lender with additional required documents, such as the purchase contract, a credit report, lease agreements, etc.
4. Close
Close the DSCR loan by signing on the dotted line. Your lender will send the loan funds directly to the settlement agent to finalize the deal.
Ultimately, DSCR loans can be a great way to build your long-term wealth. But you must first ensure your project meets a lender’s minimum DSCR and other requirements. Contact one of our DSCR loan experts today to find out if you qualify!