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So far, throughout 2023, we have published several articles on DSCR loans, a loan product that continues to grow in popularity among real estate investors. These included an overview of how to get the best rate and terms, how to use advanced strategies to maximize returns, and an overview of the new small multifamily DSCR loan niche, which expands the loan product to properties with up to 10 units!
As many seasoned real estate investors know, while investing in real estate and obtaining loans is a generally straightforward process, there always seem to be unique situations and wrinkles to every deal! The BiggerPockets forums routinely include questions related to DSCR loan qualifications. This overview will help consolidate helpful information for investors curious about this loan option!
This article will walk through many examples of frequently asked questions on all things DSCR loans and provide all the answers you will need to navigate the lending process and scale your portfolio on the road to financial freedom.
1. What are DSCR Loans?
DSCR loans are loans secured by residential investment properties, typically from one (single-family rental) to four units, but sometimes on properties up to 10 units. The loans are typically originated to be included in securitizations, either in securitizations of all DSCR loans or along with other non-qualified mortgages (“Non-QM” meaning not qualified under conventional guidelines required by quasi-government agencies such as Fannie Mae or Freddie Mac). These loans are full recourse to the borrower (or guarantor, if the borrower is an entity like an LLC) and qualify primarily based on the property’s cash flow potential rather than the income or financial situation of the investor.
Note that “DSCR loans” should not be confused with commercial real estate loans that utilize the debt-service-coverage ratio in their underwriting or similar products offered by banks and credit unions that may have similar products. Those loans are better classified as commercial real estate loans or “portfolio lender loans,” – whereas the moniker of “DSCR loan” should be reserved for this specific non-QM securitizable loan product.
2. How is DSCR Calculated For These Loans?
The DSCR calculation, while pretty basic, can confuse people, especially for investors with backgrounds in commercial real estate. Why? The DSCR calculation for DSCR loans on residential investment properties is computed by taking the rental income of a property divided by the “PITIA” (principal + interest + taxes + insurance + association dues). In contrast, the DSCR metric for commercial real estate loans is calculated by taking the Net Operating Income (Rent minus all operating expenses on the property) divided by debt service (any principal plus interest payments). The operating expenses for commercial real estate loans typically include many additional expenses on top of taxes and insurance, such as repairs and maintenance, utilities, landscaping, management fees, and estimates for vacancy and credit loss.
Thus, for DSCR loans, the DSCR that is calculated is often friendlier (i.e., higher) than sometimes expected. While it is generally smart to underwrite your rental properties as an investor by erring on the conservative side (baking in expected additional costs and reserves), it can be a smart move to use the easier qualification on DSCR loans based on this underwriting methodology.
3. Do All DSCR Lenders Have the Same Qualification Rules and Underwriting Guidelines?
No. A great thing about DSCR loans is that there are different lenders to choose from, and many have slightly different guidelines and qualification rules. Unlike “conventional” lenders, who have to 100.0% strictly follow the guidelines from Fannie Mae and other agencies, DSCR lenders have customized guidelines and allow for exceptions on top of that!
Typically DSCR lenders will have interest rates and loan terms that are very similar and guidelines that are more or less ~90% equivalent. But the differences can be meaningful, especially when DSCR Lenders commit to specializing in serving specific investor niches, such as those that specialize in short-term rentals or the BRRRR Method! DSCR Lenders also generally have the flexibility to make exceptions and not have to stick to the guidelines 100.0% (like conventional lenders). This tends to be incredibly helpful for savvy real estate investors that make their money finding ways to make deals work, even if they have a little hair on them!
4. What is the Minimum Loan Amount For a DSCR Loan?
The minimum loan amount for DSCR loans is going to vary by lender. Generally, you will likely see minimum loan amounts in the range of $75,000 to $150,000, although some lenders have been known to go down to a loan amount of $55,000.
5. What is the Minimum Credit Score For a DSCR Loan?
Like the minimum loan amount, the minimum credit score for DSCR loans will vary (sometimes widely) by the lender. Generally, the strictest lender will have a minimum as high as 680, while the more aggressive lenders will have minimums as low as 620.
6. Can I Live in a Property Bought With a DSCR Loan?
No, DSCR loans have very strict loans that do not allow the borrower to occupy the properties. In fact, as part of the DSCR loan documents, borrowers are required to sign a legal affidavit attesting that they don’t live in the property or intend to live in the property in the future. This even includes specific units in multi-unit properties. So even if the property has four units (quadruplex), and three of the units are occupied by third-party tenants, the fourth still cannot be occupied by the owner of the property.
7. What if it’s a Short-Term Rental?
Yes, for investment properties secured by DSCR loans that are used as short-term or vacation rentals, the borrower must sign the same legal documents stating they won’t occupy the property. This includes staying at the property some of the time while renting it at other times.
However, there is a little bit of leniency on these. Investors of short-term rentals with DSCR loans are allowed to stay up to two weeks annually while staying in compliance with the loan documents. For vacation properties in which the investor wants to spend more than two weeks a year occupying, DSCR loans are not an option. The good news is that “second home loans” is a widely available loan product many lenders offer for these situations.
8. Can a First Time Investor Get a DSCR Loan?
Yes, DSCR loans are generally available to first-time investors, but rules will vary by lender. While a few DSCR lenders will not lend to first-timers, most will do so, commonly with minor restrictions such as a maximum LTV lowered by 5% or requiring a higher minimum credit score. However, some DSCR lenders have no restrictions for beginner investors, especially if the rest of the borrower’s financial profile is strong.
9. What is the Lowest DSCR Loan Down Payment?
The vast majority of DSCR Lenders will have minimum down payments of 20%. However, there are a few that will go as little as 15%.
10. Is There a Maximum Amount of DSCR Loans That You Can Have?
No, unlike conventional loans, which limit to no more than 10 properties at once (and typically fewer in practice, as it becomes harder and harder to qualify conventionally once you build your portfolio), DSCR loans have no maximum because each loan will be qualified based on the property and credit score, not all the total income and expenses across a borrower’s personal income, expenses, and portfolio.
11. Do Properties Need To Be Leased To Qualify For a DSCR Loan?
Generally, for DSCR loans that are part of refinance transactions, the property must be fully leased to a tenant or have an operating history of earning rental income as a short-term or medium-term rental. For multifamily properties, some lenders will allow one or two units to be vacant for a refinance. However, these units must be “rent-ready.”
For acquisition transactions (i.e., using a DSCR loan to finance the purchase of a property), DSCR Lenders will universally allow the property to be vacant but in “turnkey” condition.
12. What are Some of the Common Reasons a Rental Property Would Be Ineligible To Be Financed With a DSCR loan?
While every DSCR lender and some may allow or potentially allow exceptions on any of the following, these types of properties are generally ineligible for financing through a DSCR loan. These are generally ineligible because the lender if needing to foreclose and take over the property, doesn’t have the needed niche expertise to successfully operate the property. Additionally, the pool of buyers (that have the expertise needed) to potentially purchase the property is much lower than the potential buyer pool for more standard residential properties.
Agricultural Properties: Properties with agricultural income-producing activities, such as ranches, farms, or orchards, are generally ineligible. If you are looking at an investment property that has a main house but also includes stables or barns, it is most likely ineligible for DSCR financing, even if the income and value solely from the home is enough to qualify.
Assisted Living Facilities: Properties that are set up for elder care (and the accompanying high and sometimes unpredictable turnover) are also generally prohibited by DSCR lenders
Single Room Occupancy Properties: While increasing in popularity because maximizing tenants can increase cash flow, properties that are rented by the room to tenants like university students are generally prohibited. Part of the reasoning here is that tenants under these arrangements can be riskier and less reliable than tenants renting an entire house.
However, DSCR loans for these properties can usually be made on an exception basis but usually require the property to be both easily converted to use by a single tenant and be able to provide enough rental income to cash flow if leased to a single tenant.
Log Homes: True vacation cabins, such as in the Smoky Mountains or other rural areas, are generally prohibited by DSCR lenders. However, it is also sometimes a grey area in what qualifies as a log cabin versus a single-family home designed in “log style.” Typically, properties with log-cabin styling but also features standard infrastructure hooked up to utilities such as HVAC, running water, and a septic system, with similar comparable properties in the area, are eligible for DSCR loan financing.
Large Acreage: Acreage limits vary by DSCR lender, but DSCR loans are typically limited to properties that sit on five acres or fewer.
Hopefully, this article helps your understanding of DSCR loans and how to evaluate investment property opportunities for which they can be best utilized!
This article is presented by Easy Street Capital
Easy Street Capital is a private real estate lender headquartered in Austin, Texas, serving real estate investors around the country. Defined by an experienced team and innovative loan programs, Easy Street Capital is the ideal financing partner for real estate investors of all experience levels and specialties. Whether an investor is fixing and flipping, financing a cash-flowing rental, or building ground-up, we have a solution to fit those needs.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.