What are DSCR loans?

Definition: DSCR loans are mortgage loans secured by residential real estate turnkey properties, strictly used for a business purpose and underwritten primarily based on the property.

Important note: DSCR loans refer to the specific loan type, and the “DSCR ratio” (debt service coverage ratio) is a metric used for underwriting and evaluating these loans (and other loans), but the metric and ratio itself are distinct things versus what is referred to as “DSCR loans.”

Some key things to note in the definition:

• DSCR loans are secured loans (meaning that there is collateral that the lender can take if the borrower doesn’t pay back the debt). They are also mortgage loans ( secured loans for which the secured collateral is real estate.)

• DSCR loans cover residential real estate properties, not commercial real estate properties. So investment properties that are commercial in nature (office buildings, retail strip centers.) cannot use DSCR loans. They can be leveraged with commercial real estate loans that use the DSCR metric for evaluation.

• DSCR loans are for “business purpose,” only meaning that the owner of the property can not live in the property under any circumstances. These loans are strictly for investment properties where the property is owned and operated for business purpose and rented out for income. Additionally, for DSCR loans for which the purpose is a “cash-out refinance,” the use of the cash-out proceeds must also be used for a business purpose. Commonly, these proceeds are used for further real estate investment (buy more assets) or costs related to the borrower’s real estate business and strictly can‘t be used for personal uses, such as paying off personal credit cards or any nonbusiness expense.

• DSCR loans are “primarily based on the property,” meaning that the lender evaluates and qualifies the deal mostly but not completely based on the property’s investment potential. This is a common misconception where people sometimes assume DSCR loans are purely based on the asset.

• DSCR lenders will run personal credit (which, along with LTV and DSCR, is among the three biggest factors determining your rate and terms) and typically require three to six months reserves in liquid assets.

• Finally, DSCR loans are turnkey, meaning any property needing any significant renovations or rehab is not going to qualify.

It is important to remember that DSCR lenders are all following the 100% exact same guidelines and requirements, such as conventional lenders originating Fannie Mae-qualified loans.

Some different documentation are required for DSCR loans

• Property insurance

DSCR lenders will require that the property is properly insured against potential damage and destruction, typically at a minimum of the loan amount or replacement cost. This ensures that if the property is destroyed, the DSCR lender can recover the funds from the loan in a payout of no less than the principal balance. Flood insurance to this amount is also required if the property lies in a federally designated flood zone.

• Leases

If the property is leased as a long-term rental, copies of the leases are required to be provided, and they must be in proper order (clearly signed with rents and terms fully clarified). One thing to watch out for is when purchasing a property that is currently leased out: things typically run the smoothest when the seller can provide these leases quickly.

• Short-term rental history

If the property has been utilized as a short-term rental, the last 12 months of bookings and receipts are typically required by the DSCR lender. Usually, these can be downloaded and sent fairly easily from short-term rental platforms such as Airbnb and VRBO.

• Renovation documentation

For borrowers who are rehabbing and using DSCR loans for a quick cash-out refinance, documentation of all the renovation work is often required. These will typically include receipts, invoices, and work orders from the rehab work on the property. So save EVERYTHING!