DSCR Loan Requirements Explained (2024 Update)

Investment properties (and real estate in general) are often considered among the safest places for an investor to put their money. Of course, getting a conventional mortgage loan can be tricky if your pay stubs or tax returns don’t show enough personal income. A debt service coverage ratio (DSCR) loan, however, can be a great solution to that problem that can help you build your real estate portfolio of investment properties.

Keep reading to learn more about debt service coverage ratio loans: who they’re good for, some of their pros and cons, and the DSCR loan requirements you’ll need to meet to qualify for a mortgage. Let’s start by taking a quick look at what a DSCR loan is and how it works.

A DSCR loan — also known as an investor cash flow mortgage — is a type of loan primarily meant for real estate investors who may not meet the income requirements needed to get a regular mortgage on a rental property. DSCR loans fall under the category of non-qualifying mortgages (or non-QM loans), which are designed for borrowers who have income that is insufficient or otherwise difficult to quantify, meaning they can’t typically get a conventional loan by traditional income verification methods.

For comparison, most lenders base a large portion of their approval decision on a borrower’s ability to qualify for a loan amount based on their W-2s, pay stubs, and tax returns — in other words, verifiable income. If you can’t prove enough personal income to cover the monthly mortgage payments, you may be turned down for a loan. This is true even if you have an excellent credit score and enough cash flow to cover a higher down payment, plus closing costs and monthly payments.

As an alternative to a conventional loan, DSCR lenders will extend a DSCR mortgage to real estate investors based on the cash flow generated by an investment property instead of their personal income. This essentially means that if the monthly rental income brought in by an investment property exceeds the monthly debt payments on it, a borrower has a better chance of getting approval for a DSCR loan.

As mentioned previously, DSCR loans don’t require personal income verification; instead, in order to gain loan approval, you’ll need to prove that you’re purchasing a profitable rental property. This means the rental property has to generate enough profit to cover the monthly mortgage payments, which include the mortgage principal as well as the interest, property taxes, and insurance on the property.

DSCR lenders will determine this value by calculating your debt service coverage ratio (DSCR). This is a key part of the process because it needs to prove that you have sufficient cash flow (in rental income from the rental property) to cover your new monthly payments.

As Matt Allen, Vice President of Portfolio Lending at North American Savings Bank (NASB), explains, “The DSCR is calculated by subtracting out the total expenses from the gross annual income (rental income paid by tenant) and dividing the net operating income (NOI) by the annual principal and interest payment on the loan. Simplified: DSCR = net operating income / debt service (principal + interest). Typical expenses are real estate taxes, hazard insurance, HOA dues, vacancy factor, property management factor, and a maintenance factor.”

For example, if your property has a net operating income (i.e., gross rental income minus expenses) of $100,000 and total debt obligations of $70,000, the debt service coverage ratio would be about 1.43, which is pretty good. According to Allen:

While DSCR loans don’t require personal income verification, there are still a number of loan requirements that real estate investors must meet if they want to acquire rental properties without needing to disclose pay stubs or tax returns.

According to Adie Kriegstein, Licensed Real Estate Salesperson at Compass Real Estate, “These loans typically require a higher down payment and a lower loan-to-value ratio than other types of loans because the lender wants to ensure that the borrower has enough cash flow to cover the loan payments.”

The most important requirement of a DSCR mortgage is (obviously) the debt service coverage ratio. Lenders generally agree that a property’s DSCR should fall at minimum between 1.1 and 1.2, but the higher the DSCR, the better the loan terms and interest rates you can secure. Typically, having a higher debt service coverage ratio also means you can qualify for a higher loan amount.

Like most other mortgages, DSCR loans require a down payment to secure a mortgage loan. However, the down payment for a DSCR loan is typically higher than for standard investment property loans: some lenders may even require as high as 30% of the purchase price as a down payment on a DSCR loan (depending on the loan amount and other factors). That said, as Allen explains, the minimum requirement may be less: “A DSCR lender normally requires a 20% minimum down payment.”

DSCR lenders may not check your personal income, but they will still look into your credit history to make sure you have handled your previous debts responsibly. According to Allen, there is usually a minimum credit score required of at least 620. However, many DSCR loans may require a minimum credit score of 700 or more.

Before you can qualify for a DSCR loan, you will need to have the investment property appraised. This is common practice with all real estate transactions, but an additional step for a DSCR loan is to check rental income from comparable properties. According to Allen, you need “a full appraisal that includes rental comps to document the going market rent for a similar type of property in the surrounding area of the subject property.”

In addition to other DSCR loan requirements, lenders typically want to see a lower loan-to-value ratio. The LTV ratio is calculated by taking the DSCR loan amount and dividing it by the appraised value of the property.

To give a simple example, imagine the appraised value of the property and the loan amount are both $200,000. If you make a down payment of 20%, the loan amount will be $160,000. Dividing that number by the appraised value of $200,000 gives you an LTV ratio of 80%, which is basically the lowest ratio you can use to qualify for a DSCR loan.

Finally, DSCR loan lenders will want to verify you have the funds needed for the down payment on the loan, as well as sufficient cash reserves in case you run into a cash flow problem. Also keep in mind that any lender from whom you try to obtain a DSCR loan will need to verify your identity with a passport, driver’s license, or other form of government-issued identification.

DSCR loans are often good for real estate investors who can’t prove sufficient personal income to get approved for conventional loans. As Allen explains, this is often because of the special tax circumstances that real estate investors have access to:

Some real estate investors can also benefit from debt service coverage ratio loans even if they can prove they earn enough money for a traditional mortgage without including rental income. For example, most lenders also look at a borrower’s ability to cover monthly mortgage payments based on their debt-to-income ratio. This could potentially be an issue for an investor who has multiple rental properties and plenty of personal income but a high debt-to-income ratio. If you fall into this category, a DSCR loan might be right for you.