DSCR loans for rental property
The short version
A DSCR loan qualifies an investment property on its rent rather than your personal income. DSCR stands for debt service coverage ratio:
Monthly rent ÷ monthly PITIA = DSCR
PITIA is principal, interest, property taxes, insurance and association dues. At 1.0, the rent just covers the payment. Above 1.0, the rent more than covers it.
Each lender sets its own rules. Many require 1.0 or higher and offer better pricing around 1.2 to 1.25, and some accept less than 1.0 with a larger down payment. Down payments, reserves and score minimums vary by lender. You should expect to put down more than you would on a home you live in.
Your personal income is not used to qualify, so there are usually no pay stubs or tax returns. Lenders still check your credit, assets, reserves and the property.
Short-term rental rules vary across Southwest Colorado. Towns and counties may require permits, limit where short-term rentals are allowed or cap their number. It is wise to check the local rules before you count on short-term income, and to know what the home would rent for long term.
Go deeper
Where the rent figure comes from
- A rented property: the current lease, often checked against market rent.
- A vacant home or a new purchase: the appraiser's market rent survey.
- Short-term rentals: some lenders use 12 months of booking history or a market data report. Others will not count it. Rules vary widely.
Some lenders use the lower of the lease and market rent, so do not count on above-market rent to qualify.
An example
Suppose market rent is $2,400 a month, and principal, interest, taxes, insurance and dues add up to $2,000.
$2,400 ÷ $2,000 = 1.20
To reach 1.0, rent would need to be at least $2,000. To reach 1.25, it would need to be $2,500. If the ratio comes up short, a larger down payment lowers the payment and raises the ratio. Lower taxes or insurance raise it too, so it helps to get an insurance quote before you settle on a price.
Costs and fine print
- Higher rates than conventional investment loans, in exchange for not requiring income documents.
- Prepayment penalties are common: a fee if you pay off or refinance in the first few years, often stepping down each year.
- LLCs: many lenders let you close in a business name.
- Reserves: counted in months of payments. The amount varies by lender.
A loan for a rental you will not live in is business-purpose credit under federal rules, so many consumer mortgage protections do not apply. Read the note and any prepayment terms closely.
DSCR or a conventional investment loan?
Conventional investment loans use your tax returns, and count rent at 75% of the gross to allow for vacancy and upkeep. They usually cost less when your returns show enough income. Fannie Mae asks for six months of reserves on an investment property, and sellers can pay no more than 2% of the price toward your costs.
DSCR loans can fit when your returns do not show enough income, when you own several properties, or when you want to close in an LLC.
See it with your numbers
Your Mortgage Plan compares conventional, FHA, VA and USDA loans. For a DSCR loan, Daniel works from a lender’s quote and shows you the payment and the ratio against the rent before you commit.
Back in your Mortgage Plan, see this with your own numbers.
Your next step
Stage 6: OwningBecoming an investorReal estate investing can start with a 2 to 4 unit home you live in, renting out your old home or buying a rental. Lenders usually count 75% of rent.Read the lessonOr go another way: I am also self-employedContinue in order: Renovation loans: buy and fix in one loan