Really, what are DSCR Loans…?

Question

Hi all, I’m new to bigger pockets forum but have been a fan of the blog since maybe 2013. I’ve seen friends achieve success in following its guides and receiving insight from the BP community. I got rid of my social media and decided this would be a good way to interact online while also educating myself and staying informed. I’ve been a commercial real estate underwriter since 2012 and specifically now work as an underwriter for multifamily rental/condo construction projects nationally. In 2012-2014, I also underwrote residential loans (DTI) at a local community bank.

One thing I’ve noticed come up a lot is the term “DSCR Loans.” I am extremely confused when I see this term because in 10 years of working in lending, I’ve never heard of this before. DSCR itself (the ratio) is a metric that I analyze every single day but I’ve never heard it used in this manner.  In commercial lending, DSCR is just a metric, it’s not a program or loan product, so I assumed that “DSCR Loan” really just means “Commercial Mortgage” but as I continued to google DSCR Loan trying to find a clear answer, I found differing feedback.

DSCR = NOI/annual debt service, this I know for a fact, and generally banks require 1.2x. When I search DSCR Loans I found 1) sites indicating that a bank would require a minimum 1.0x DSCR and 2) incorrect definitions/calculations of DSCR. I also found guides saying that the minimum credit score required is 620 and that there is no income verification (no W2s, tax returns, etc). I also found something saying that DSCR Loans began in 2019…?

All of this is very confusing because I can legitimately say that I am a specialist in real estate financing for investment purposes but this makes me think that this is a loan product for investors in residential 1-4 family homes held for rental, as opposed to a commercial multifamily building (5+ units or retail/industrial/office,etc.).

Lastly, as a prospective owner/investor myself looking to get into purchasing RE, is this a loan product that I could look into at a mortgage bank to purchase a house meant for long term rental or Airbnb, for example? I appreciate any feedback and guidance on this point because most of the sources I’ve found have seemed either oversimplified, inaccurate (maybe a misnomer) or possibly just foreign to me (because it’s a newer residential loan product for investment purposes). Thank you for your help!

Zach Edelman · Answer

DSCR in the residential space, and for any true DSCR lender, is calculated as gross monthly rental income/monthly PITIA, not NOI/Annual Debt Service. That is the calculation used for commercial assets/via true commercial lenders.

Stacy Raskin · Answer

@Rich Cadena, DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth.

Personal income is not needed for these loans to structure them. The only personal income that is verified is for example to show the transaction history for a down payment.

Regarding details you mentioned in your post, there are nationwide lenders that specialize in DSCR loans will do DSCR ratios down to .75% so an easy math example would be that the lender will underwrite a loan for $750 in rent for $1,000 expenses. This will require a higher down payment or less cash out if a refinance.

Generally speaking lenders that specialize in investment property / DSCR loans will go down to 1 DSCR ratio or $1,000 expenses to $1,000 in rent with favorable terms such as 20% down if a purchase or 75% if a cash out refinance.

If 1.2 DSCR ratio, you will get better terms such as $1,200 rent for $1,000 expenses for easy math. Generally banks are more conservative for lending on DSCR loans so they have stricter underwriting standards which is why they may require a 1.2 ratio to do a DSCR loan at all. Working with lenders that specialize in DSCR loans will get you better terms.

There are lenders that will do a DSCR loan with a middle mortgage credit score of 620 but the borrower will have to put more money down if a purchase or get less money out if a refinance.

There are lenders that will do DSCR loans for foreign nationals (so no U.S. credit lines).

There are 1-4 unit DSCR programs (so single family to fourplexes) and 5-8 unit programs. The 5-8 unit programs have a little bit of stricter underwriting and take a little longer to close. 1-4 unit DSCR programs typically can close in 3-4 weeks if the appraisal is scheduled and turned in and the borrower gets all paperwork back in a timely manner.

5-8 unit programs generally are 30-45 days to close.

There are fixed 30 year fully amortized mortgage options for both. There are also programs where there's a 40 year term where there's 10 year interest only period followed by 30 year fully amortized. A borrower can qualify off of the interest only payment.

There are programs that structure the loan for an Airbnb rental for 1-4 units. From programs I've worked with, If a purchase, you would need at least one year of Airbnb experience plus having owned two investment properties for more than one year or one investment property for more than two years (in the most recent 2 years). The  lender would use AirDNA and apply a 20% expenses factor so if the annual projected rent is $120,000 per year. The lender would take 20% off for expenses so we would then have $96K (100,000 *80%) and divide by 12 (months) so they would use $8,000 a month to structure the loan. The loan's new mortgage, property taxes, insurance and HOA (if applicable) would have to be at or under $8,000. The lender would require a 1.2 DSCR ratio if structuring as a short term rental loan which we have since we took a 20% expense factor. A lender will also use Airbnb, VRBO or other short term rental history for a cash out refinance if the borrower has at least one year of Airbnb rental experience in the most recent time period and take a 20% expense factor.

Here's a bit more in detail about how rates are calculated for DSCR loans:1. Credit score- the higher the best. 760+ generally gets best pricing for investment property loans with most lenders2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.3. Prepayment penalties- usually 1-5 year terms. The shorter the prepayment term has an impact on increasing the rate.4. Are you cash flowing the property? Is your DSCR ratio greater than 1-meaning are you cash flowing. Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing for the rate takes a hit.I've included an example below to help illustrate this.So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.See example below:DSCR < 1Principal + Interest = $1,700Taxes = $350, Insurance = $100, Association Dues = $50Total PITIA = $2200Rent = $2000DSCR = Rent/PITIA = 2000/2200 = 0.91Since the DSCR is 0.91, we know the expenses are greater than the income of the property.DSCR >1Principal + Interest = $1,500Taxes = $250, Insurance = $100, Association Dues = $25Total PITIA = $1875 Rent = $2300DSCR = Rent/PITIA = 2300/1875 = 1.23

DSCR is greater than 1.2 so will qualify for 1 ratio and 1.2 ratio programs.DSCR lenders generally let you vest either individually or as an LLC. It's a great way to increase your net worth and these loans can also be used to pull cash out of a property as it appreciates allowing you to reinvest money into new deals.

Ethan Cramer · Answer

DSCR Loans are good product for the right property and borrower. My bank offers them and we like to see the property has consistent cash flow ability and the borrower has at least 1 year of operating real estate as a landlord. let me know if you have any more specific qualifying questions!

Matthew Drouin · Answer

@Rich Cadena

Don’t feel bad about not knowing about the newest addition to the real estate alphabet soup!

Truth be told, I’ve been using “DSCR loans” since I bought my second property back in 2008.  These have been the portfolio loans (on balance sheet) lending that is typically offered by community banks.  The property usually needs to meet a DSCR covenant of 1.2 or 1.25.

Community banks kept investors growth alive during the financial crisis as all of the non confirming exotic loan products provided by institutional lenders (typically backed by hedge funds) were pulled off the shelf after the collapse.

Now as things have become more normal, non confirming (not fannie freddie) loan products have begun to trickle back into the market place as institutional capital has developed a thirst for yield backed by hard assets like real estate.

These DSCR loans you have heard buzzing about are not agency backed products so therefore there is not the hard and fast rules that you see with conventional.  What that means is every DSCR lender is different in their criteria.

The first DSCR borrower of this type (2018) that I knew was an STR investor who over renovated a property using hard money and couldn’t find a local bank to help them refi it because they couldn’t get the property to appraise at a 80% ltv to give them loan proceeds to take their hard money lender out.

They found a lender that had a product that as long as they could show consistent revenue to meet at least a 1.3 DSCR for 12 months (the seasoning period) that the lender would do the deal regardless of appraisal (even though they required an appraisal to understand their exposure).  The borrower needed to have a good credit score.  They ended up getting the loan at a premium to appraised value because the revenue was sufficient to meet this particular DSCR requirements.

The fact of the manner is all of these lenders that offer DSCR loans may have different requirements so if you are going to go this route you may need to do research to see who would do your prospective deal.

Perhaps you might not even need to go this route and your deal could qualify for conventional or with a portfolio loan from a community bank or credit union.

Hope this helps!

Erik Estrada · Answer

Hello Rich,

Sounds unbelievable, but there are some lenders that do not even have a DSCR requirement at all. As long as the lender likes the property, you have some experience, have an LLC, and you have 20-25% down, you are good to go. 30 year fixed loan with sometimes, no prepayment penalty.

But for the most competitive terms, lenders like to see a 1.00 DSCR on LTRs, FICOs above 700, and 2 or more properties owned. You may use a market rent 1007 or lease agreements for the rental requirement.

STRs are a little more strict. Lenders want to see that you have 12 months of experience operating a short term rental property or the property having 12 months of short term rental history. You may use short term market rents or 12 months of booking history to qualify for the rental requirement. Most lenders are at 25% down, although a handful can do 20% down.

DSCR is essentially a stated income loan. No personal tax returns required to qualify.

Some lenders like to see 3-6 months of reserves in addition to the DP + closing and some don't have any resreve requirements.

Also many do not source deposits or require seasoning of funds.

Devin Peterson · Answer

Hi Rich, Great research. Nailed it on the head with the Q's! I hear a lot of the same you are referring to when folks ar first looking to inquire about DSCR. A few salient points...

- DSCR loans can be used for 1-4 Units AND 5+ multifamily houses / smaller apartments. The process is more or less the same its just that depending on lender overlays any 5+ unit could be subject to "commercial" guidelines and require and environmental test, different occupancy requirements, etc. just small things. BUT the overall approval and qualifying process is the same.

- YES DSCR can be used for STR. Lenders will typically like to see that you have some STR experience but fear not if you don't, there are ways to get creative. The AIRDNA STR rental income would replace the long-term monthly rent in this DSCR 1.00> required calculation. STR properties generally require: B grade or better on AIRDNA, 65% or more occupancy, and a T12 statement from either you or the seller on the properties past performance record if avaiable.

Really, what are DSCR Loans…?

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