Our guide covers everything you need to know about the pros and cons of DSCR loans.
DSCR loans are underwritten based on an investment property’s ability to cover its mortgage payments with the rental income received by tenants. DSCR lenders don’t consider a borrower’s personal financial profile when underwriting.
For example, say you purchase a single-family home with a loan that costs $1,000 per month in PITI (Principal, Interest, Taxes, Insurance), and the tenant pays $1,200 per month in rent.
In this scenario, the property would have a DSCR of 1.2. Lenders use this DSCR figure during underwriting; naturally, the higher the property’s DSCR, the better your chances of qualifying for a loan and securing lower interest rates.
Because DSCR lenders don’t evaluate your financial profile, you don’t have to submit income verification, W2 forms, and other documents that mortgage lenders typically require. This makes DSCR loans an attractive option for:
However, DSCR loans come with some drawbacks. Namely, borrowers typically need a larger down payment, ranging from 20% to 25%, compared to regular mortgage loans. Additionally, DSCR loans often carry slightly higher interest rates than conventional loans.
This article reviews the pros and cons of DSCR loans and provides guidance on what to look for in a DSCR lender to ensure your loan doesn’t fall through at the last moment.
You can use our DSCR loan pricer to test out different loan scenarios.
The main advantage of DSCR (Debt Service Coverage Ratio) loans is that they aren’t underwritten based on your financial profile. These lenders don’t consider your personal income, employment status, or debt-to-income ratio. Instead, DSCR lenders primarily focus on a property’s DSCR and LTV (loan-to-value) ratio.
Typically, DSCR lenders only require entity documents, proof of insurance, proof of identification, a credit report, and bank statements to verify that you have enough capital for the down payment.
This makes DSCR loans a strong option for self-employed borrowers who may struggle to qualify for conventional mortgages from large banks.
Read more: DSCR Loan Requirements: 5 Key Factors Lenders Consider
Another limitation of using regular mortgages to purchase investment properties is that banks often restrict the number of mortgages you can have simultaneously.
While Fannie Mae and Freddie Mac's guidelines theoretically allow up to 10 mortgages, in practice, many borrowers find it difficult to qualify for conventional financing after three or four mortgages due to their high debt-to-income ratio.
This is where DSCR loans come into play. Since DSCR lenders consider your debt-to-income ratio when underwriting, nor do they require details about your current investments and debt obligations, you can use DSCR loans to expand your portfolio beyond what's possible with conventional financing.
Furthermore, because many DSCR lenders, including us at Constitution Lending, evaluate the borrower's real estate investing experience during underwriting, it can actually become easier to qualify as you take out more loans.
Read more: 5 Best DSCR Lenders (2024 Comparison)
Before we founded Constitution Lending, we invested in real estate and noticed that DSCR lenders often close loans faster than banks issuing traditional loans.
Larger banks typically take between 40 and 75 days to close a loan. This lengthy application process makes it difficult to compete with cash buyers and exposes borrowers to potential changes in the bank’s lending criteria. This creates a “moving goalpost” problem, where borrowers might initially qualify, but if the bank’s lending criteria change during the 75-day process, they could face sudden rejection.
In contrast, DSCR lenders, including Constitution Lending, often close loans within 14 to 30 days. In some cases, we’ve even completed the process in just 7 days when borrowers needed a faster closing.
This efficiency is due DSCR lenders not requiring documents like paystubs, W2 forms, and proof of employment, and not evaluating a borrower’s debt-to-income ratio. This streamlined approach speeds up the application and underwriting process, allowing borrowers to close quickly.
DSCR loans are primarily underwritten on three main factors: the property's DSCR, the borrower's credit score, and a minimum down payment of 20% to 25%. If you meet these three qualifications, there's a high certainty that your loan will get approved.
In contrast, traditional mortgage loans are underwritten based on multiple qualifications, such as the borrower’s income level, employment status, debt-to-income ratio, credit score, and more. This complex evaluation often leaves borrowers uncertain about their ability to qualify.
Additionally, the shorter closing period for DSCR loans — typically within 30 days — compared to up to 75 days for conventional mortgages, further enhances their reliability. The quicker closing reduces exposure to changing credit environments, which can impact eligibility.
One of the main drawbacks of a DSCR loan is that you need a down payment of around 20% to 25%. This is significant compared to conventional mortgages, which usually ask for a 3% to 5% down payment.
While this high down payment might initially seem like a disadvantage, it serves as a safety mechanism to prevent borrowers from overleveraging themselves.
A larger down payment increases the property’s DSCR and thus gives the borrower a margin for volatility. If real estate markets experience a downturn, for example, or the property is left vacant for a few months, borrowers can use the cash flow saved from previous months to cover mortgage payments and other operating expenses.
At Constitution Lending, we frequently encounter inquiries about zero down payment DSCR loans. However, such loans do not exist and would place borrowers in precarious, overleveraged positions. In the event of vacancies, payment delays, or market downturns, borrowers could face negative cash flow and would need to cover the entire mortgage themselves.
Another important factor DSCR lenders consider is the borrower’s credit score. DSCR lenders generally require a higher credit score than traditional mortgage lenders, typically 700 or higher. At Constitution Lending, we accept a minimum credit score of 660.
Borrowers often wonder why their credit score matters if DSCR loans are underwritten based on the property’s cash flow rather than their personal financials. The reason is that rental properties aren’t profitable on their own; they require active management to become income-generating investments. This includes finding reliable tenants, handling property maintenance and repairs, collecting rent, and managing overall property operations.
Credit scores are the best metric lenders have to gauge a borrower’s competency. If a borrower cannot pay their credit card or home mortgage on time, for example, it’s unlikely they’ll be able to manage a portfolio of rental properties.
DSCR loans are often viewed as more speculative compared to traditional mortgage loans due to their reliance on timely tenant payments. As a result, they typically come with higher interest rates to account for this additional risk.
However, this isn’t always the case. If demand for DSCR loans from accredited and institutional investors rises, the borrower credit spread or risk premium can decrease, leading to lower interest rates.
In fact, at the time of writing, Constitution Lending is offering interest rates as low as 6.75%, which is comparable to traditional 30-year mortgages.
Read more: DSCR Loan Rates in 2024: 5 Factors That Impact Interest Rates
Prepayment penalties are fees borrowers pay when they want to refinance their loan within a specific time period, usually within five years of the closing date.
Conventional loans don’t have prepayment penalties, so borrowers can refinance at a lower interest rate as early as they want.
Because DSCR loans are business loans and not personal loans, they have less consumer protection (more on this later), and borrowers will have to pay a penalty for refinancing at a lower interest rate.
These prepayment penalties help lenders (and loan investors) recover the money they would’ve earned in future interest payments.
At Constitution Lending, we offer a variety of prepayment penalty terms that you can choose from depending on how soon you expect to have to sell or refinance the property. But keep in mind that the lower the prepayment penalty and the shorter the prepayment penalty term, the higher your interest rate.
Because DSCR loans are considered business loans, the government assumes that the individuals applying for them are knowledgeable real estate investors with a deep understanding of the loan terms they are agreeing to.
This is why there is less consumer protection for DSCR loans, resulting in the drawbacks mentioned above, such as higher interest rates, down payments, and prepayment penalties.
On the other hand, consumer loans like mortgages are meant for retail individuals who may not have a good understanding of their loan terms. In order to protect these borrowers, the government mandates strong consumer protection features like zero prepayment penalties, lower down payments, and lower interest rates.
To qualify for a DSCR loan, some lenders require borrowers to have purchased at least one investment property, have a 24-month payment history, and no late payments within the last 12 months.
This requirement ensures the borrower has the real estate expertise needed to identify profitable investment opportunities, manage properties effectively, and make timely loan payments.
At Constitution Lending, we don’t require previous real estate experience to qualify for a DSCR loan, though having it can be beneficial. As direct lenders providing our own capital, we have the flexibility to make exceptions to help you qualify. However, please note that with less real estate experience, you may face a lower LTV ratio and higher interest rates.
The last disadvantage we’d like to discuss isn’t related to DSCR loans themselves but rather the lenders issuing them.
The DSCR loan industry is relatively new, loosely regulated, and growing rapidly because of the pros we’ve covered. This has attracted many loan brokers and hard money lenders looking to earn a quick commission but who aren’t knowledgeable about DSCR loan program criteria.
These brokers aren’t lending you their funds; they simply connect you to another lender. Since they aren’t the decision maker on your loan and don’t create the criteria, they won’t know if you qualify by simply looking at your documents and qualifications. They have to ask the lender to start underwriting before they can get back to you with loan approval. This can cause brokers to initially approve your loan only for the actual lender to reject it after underwriting.
At Constitution Lending, we’re direct lenders, meaning we fund your real estate loan using our own capital without relying on third-party lenders.
As we use our own funds, we set our own criteria and have a deep understanding of borrower needs. This allows us to quickly assess your documents, determine your likelihood of qualification, and outline the loan terms you can expect. Unlike traditional lenders who might require a third-party lender to begin underwriting before providing answers, we can offer immediate feedback and a clear path forward.
If you’d like to see what loan terms you qualify for, use our DSCR loan pricer to get a quote within seconds.
Simply enter the location of the property you want to purchase, the type of property it is, and your credit score, and we’ll give you three loan options.
You can then adjust the property value, loan amount, NOI (Net Operating Income), and LTV, and our pricer will show you the interest rate you qualify for, your monthly payment, and your DSCR.
If you’d like to apply for one of these quotes, simply click on it, enter your contact details, and we’ll send you a pre-approval letter and term sheet, usually within 24 hours. Following that, we’ll grant you access to our document portal where you can submit all the necessary paperwork.
Once we review your documents, we’ll provide a definitive answer regarding your eligibility. This streamlined approach speeds up the loan application process and avoids lengthy phone conversations often required by most DSCR lenders.
Related reads:
| Qualification | Requirement |
|---|---|
| Minimum and maximum loan amount | $150,000 to $3,000,000 |
| Type of property | Non-owner occupied single-family, multi-family, and 5-8 unit properties |