A Debt Service Coverage Loan (DSCR) is a type of mortgage loan that investors will use to finance income-producing investment properties.
A typical mortgage loan, like a conventional loan, uses the income from the borrower’s employment as the qualifying source of repayment for the loan. A DSCR loan, by contrast, uses the income from the property as the source of repayment for the loan. This leaves the borrower’s personal debt-to-income ratio (the ratio of the mortgage payment amount relative to employment income) unencumbered by the loan for the investment property.
DSCR loans can be a great option for residential real estate investors who invest in long-term rentals, short-term rental properties like Airbnbs, and other strategies. And since the source of repayment is the rental income of the specific property, and not the investor’s other sources of income like employment or other investments, it enables them to scale a portfolio of investment properties.
The way that DSCR loans are calculated is by dividing the rental income from the property by the PITIA payment (PITIA stands for principal, interest, taxes, insurance, and association dues if applicable). A DSCR of 1.0x means that the property is break-even: rental income equals PITIA. A DSCR of 1.2x means that rental income exceeds PITIA by 20%, so the property is potentially cash-flowing (depending on the amount of other expenses like maintenance, utilities, etc). A DSCR of 0.8x means that the property’s rental income is insufficient to cover 80% of the PITIA payment.
You might think that a lender wouldn’t do a DSCR loan that’s 0.8x - the income is less than the payment. But that’s not the case actually. There are many lenders who will underwrite DSCR loans at <1.0x, though the borrower will need to have other financial qualifications to make it work. Some lenders will also do interest only DSCR loans.
DSCR lenders will generally underwrite the property’s rental income using a combination of in-place market rent and an appraisal form called the 1007 Form. The lender will typically use the lower of current rents or the results of the appraisal. Not all lenders and appraisers understand how short-term rental income factors into these methods, so it’s critical to select a lender who does.
Loan amounts typically max out around $2.5 - $3m. Borrowers can finance up to 80% LTV on purchases (70% on cash out refinancing). Minimum FICO scores are generally around 640 - the higher your credit score the more you can borrow. Some lenders require previous residential real estate investment experience, others will lend to first-time borrowers. Borrowers can purchase and hold title in an LLC.