What’s a DSCR Loan and Should You Get One?

If you’re a real estate investor trying to scoop up your next rental property, a DSCR loan, or debt service coverage ratio loan, may be a good financing option. This type of small-business loan is easier to qualify for than a conventional loan, but can be more expensive.

Consider a DSCR loan if you:

• Can’t qualify for a conventional loan.

• Plan to buy multiple properties.

• Have enough cash on-hand to pay at least 20% upfront. 

DSCR loans are used to buy rent-ready, income-generating properties, such as single family homes, multi-unit properties or office buildings.

Potential borrowers qualify based primarily on the property’s debt service coverage ratio, which measures a borrower’s ability to pay back a loan using the property’s projected rental income. The higher this ratio, the more profitable a rental property will be — and the more likely you’ll qualify for a DSCR loan.

In contrast, conventional loans focus more on a borrower’s personal income, assets and credit score as the main qualification criteria.

To calculate the debt service coverage ratio, divide a property’s monthly rental income (or projected income) by the loan payment, which includes principal, interest, taxes, insurance and homeowners association fees.

DSCR = Monthly rental income / Monthly loan payment

A DSCR above one indicates a borrower’s ability to pay back a loan using the income the rental property generates.

For example, if you’re buying a rental property that you think can bring in $3,000 in monthly rent and the loan payment is $2,500, the DSCR would be 1.2. This means that you would earn $1.20 in rental income for every $1.00 you pay toward the loan.

The higher the rent or the lower the loan payment, the higher the DSCR will be.

Qualification requirements vary across lenders and property types, but generally, you’ll need:

• A DSCR of around 1.25 or higher for the property being financed. This is verified by the lender through a property appraisal.

• A fair credit score (630 to 689) or higher.

• Down payment of at least 20%.

• Minimum loan amount of around $100,000.

• Three-to-six months’ worth of mortgage payments set aside to cover vacancies or emergency expenses.

• A rent-ready property (no fixer-uppers allowed).

Ready to apply for a DSCR loan? Follow these six steps.

Find a property that’s move-in ready or one that needs only light, cosmetic repairs that can be fixed quickly.

You’ll also want to consider whether the property is in an area with low vacancy rates, strong job opportunities, nearby amenities, steady population growth and reasonable property taxes and insurance rates. And don’t forget to check local rental rules or restrictions that could affect your ability to rent it out, such as those set by many homeowners associations.

Finding the right lender is an important step in financing any real estate deal. While some large and regional banks offer DSCR loans, there are many online lenders that specialize in them and cater specifically to real estate investors.

Whichever route you take, make sure you choose a reputable and experienced lender. Look for third-party reviews or feedback from other investors on forums like Reddit to get real-world insight into lenders you’re considering.

As you narrow down options, start gathering loan details from each lender, including:

• Typical interest rates (and whether they’re fixed or variable).

• Any prepayment penalties or upfront fees you might need to pay, like origination fees or closing costs.

• Minimum requirements for down payment, credit score and loan amount.

Once you’ve gathered loan details from different lenders, you can plug them into NerdWallet’s DSCR loan calculator, along with property costs and estimated rental income to get a clearer picture of:

• Whether the investment is likely to be profitable. A DSCR above one means the property’s rental income will exceed monthly mortgage payments.

• Your chances of qualifying for a DSCR loan. The higher the ratio, the more likely you’ll be approved for a loan. Compare your estimated DSCR against the minimum requirements set by lenders you’re considering.

Although documentation requirements can vary by lender, be ready to submit the following when applying for a DSCR loan:

• Authorization for the lender to pull your credit report.

• Two months of bank statements to verify you meet any cash reserves requirements.

• Proof of property insurance, which you’d provide by securing a policy and setting its start date as the scheduled closing date.

• Copies of lease agreements (for tenant-occupied properties). These may be supplied by the seller or their management company during the due diligence period. 

• Business entity documents (if you’re applying through an LLC or other entity).

• Existing mortgage statements and payment history (if refinancing).

After you apply, the lender will provide a loan estimate outlining key details of the loan, including the projected interest rate, closing costs and other terms.

Upon accepting the initial loan estimate, the lender will order a property appraisal, which you’ll have to pay for. This appraisal evaluates the property’s market value and rental income potential.

During underwriting, the lender uses the appraisal to make sure the property meets its DSCR requirement and determine your eligibility for the loan.

If you’re approved, your lender will send over a business loan agreement, which outlines the loan’s terms and conditions, such as the loan amount, final interest rate, monthly payments, loan terms, closing costs and more. Make sure you review this document carefully before you sign on the dotted line.

Upon signing, you’ll pay any closing costs and receive the funds to buy the rental property or refinance the loan.

If a DSCR loan isn’t right for you, consider these alternatives:

• Commercial real estate loan. If you want to finance and rent out a commercial property through your business, such as an apartment complex, office building, warehouse or retail space, a commercial real estate loan may offer the flexibility you need. However, these loans typically come with stricter qualification requirements and shorter repayment terms compared with DSCR loans.

• Conventional mortgage. For first-time real estate investors with strong credit and stable income, a conventional investment property mortgage may offer more competitive rates and terms compared with a DSCR loan. However, it may not be the best fit if you plan to purchase multiple properties or invest in a multi-unit building, such as an apartment building. That’s because conventional mortgages have restrictions on the number of properties you can finance.

• Fix and flip loans. These short-term hard money business loans are ideal for investors looking to buy and renovate a property with the intent to sell it or rent it out later. Typically lasting 18 months or less, they provide quick access to money for fixer-uppers. Once the renovation is complete, you can refinance the property into a long-term loan, such as a DSCR loan, and begin generating rental income.

• SBA loan. While not designed for traditional rental properties, SBA loans can be used to buy or build commercial real estate. In order to be allowed to rent out a property purchased with an SBA loan, your business would have to occupy at least 51% of the space (or more in the case of new construction). These loans offer competitive interest rates and long repayment terms, but qualifying can be challenging due to strict eligibility requirements and documentation.