Easy Street Capital is America’s leading DSCR Lender. With over $500,000,000 across more than 1,500 DSCR loans funded in the last two years, we have helped real estate investors across the country achieve financial freedom through this popular loan product. DSCR Loans allow real estate investors to qualify with no W2, no tax returns and no income verification required! See below for a comprehensive guide for everything you need to know about DSCR Loans!
The Future of DSCR Loans – 2024 and Beyond
DSCR Loans are a constantly evolving loan product. What innovations or additions to the DSCR Loan Product are on the horizon? Check out our article on the Next Frontiers in DSCR Loans, or click here for a brief synopsis.
Table of Contents:
What is a DSCR Loan?
A DSCR Loan is a mortgage loan for a residential income-producing property. It is primarily based on the “Debt Service Coverage Ratio” or the cash flow of the property, rather than the borrower’s income. A traditional mortgage loan will require income verification, tax returns and a “Debt-to-Income” (DTI) ratio. DSCR Loans require none of these! Perfect for real estate investors ready to scale (no more W2!) or are looking leave behind the hassle, paperwork and headaches of conventional financing, DSCR Loans are quickly becoming the go-to loan option for real estate investors. Read On for everything you need to know about DSCR Loans, including how to qualify, how to get the best rates and terms and answers to any and all frequently asked questions.
For a comprehensive 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.”
Note:
- Mortgage Loans = form of loan that is secured by collateral, collateral = real estate
- Residential Real Estate = properties used for people to live in vs. commercial, which is used to operate businesses (offices, retail, industrial, hotel, self-storage, etc.). In real estate finance, residential also typically refers to “1-4 unit” properties, anything more would be considered “multifamily”
- Business Purpose = DSCR loans strictly do not allow the owner of the property to live in the property, it must be used for “business” or investment purposes. Includes use of “cash-out proceeds”
- Underwritten = How lender evaluates (and then prices) the risk of the loan
- Primarily Based on Property = Mostly based on property, but also look at sponsor
- Turnkey = property doesn’t require any renovation, “turn the key and go”
Read On for everything you need to know about DSCR Loans, including how to qualify, how to get the best rates and terms and answers to any and all frequently asked questions.
Who are DSCR Loans For?
DSCR Loans are for investors in residential real estate rental properties and are perfect for investors in many diverse situations. Anyone from a first-time real estate investor to a seasoned pro looking to scale a portfolio can use DSCR Loans. The beauty of DSCR Loans is that they are a flexible solution for investors with an easy qualification. This is in contrast to conventional financing which has to follow the rigid and strict rules handed down by the agencies such as Fannie Mae and Freddie Mac.
DSCR Loans are generally a great loan option for:
- Self-employed or Freelance people looking to invest in real estate.
Its extremely difficult to qualify for conventional financing for investment properties when you don’t have a W2. Traditional lenders will like to see two years worth of steady employment and income for investors. Additionally, they will then use this information to calculate a “DTI” ratio that adds another hurdle. DSCR Loans present a perfect alternative as they do not utilize W2 income, income, or DTI in the qualification process. Qualification is based on the income potential of the property, not the personal income of the borrower.
- People who invest in real estate with partners or a team.
When it comes to investing in real estate, partnering often makes a lot of sense. Its often true that “teamwork makes the dream work” when dreaming of financial freedom. Many investors have found success partnering with other investors that have complementary skill sets. Some examples include investors with capital ($$$ for down payments) but not time teaming up with people willing to do the hard work of finding deals and managing the properties. Maybe one investor is a “numbers guy” while the other is an expert at negotiating deals! Or someone wants to invest out of state in a more affordable market, but wants a partner with boots on the ground in the local market. DSCR Loans are ideal for partnerships because unlike conventional financing, borrowers can borrow in a partnership or LLC (limited liability company) and share ownership!
- Investors pursuing niche strategies like Short Term Rentals or the “BRRRR Method”
While real estate investors are using the loan product for newer, more profitable strategies, they typically use DSCR Loans for straightforward rental properties such as SFR investments (single family rentals) on long-term (12-month) leases. Conventional lenders such as banks are slow-moving to adapt to changes, and continue to typically frown on newer strategies. In contrast, DSCR Lenders, especially forward-thinking and innovative ones like Easy Street Capital, are flexible and friendly to investors specializing in these newer niches. Investors looking to max out cash flow and qualify creatively when investing in short term rentals or the BRRRR Method find DSCR Loans to be the perfect product.
How do you calculate DSCR?
For DSCR Loans, the DSCR ratio is calculated by dividing the Rental Income from the property by the “PITIA” or the principal + interest + taxes + property insurance + association dues (if in an HOA). Essentially, this is calculating the income earned from the property divided by the expenses to operate. A DSCR ratio of 1.00x then means that you are “breaking even” or your revenues equal your expenses. A DSCR ratio over 1 means you are making cash flow. In contrast, a DSCR ratio under 1 means you are losing money.
DSCR Loan Calculator
There are some important things to know when calculating the DSCR ratio for DSCR Loans.
- The DSCR Ratio for “DSCR Loans” is typically calculated differently than the DSCR Ratio for commercial real estate loans. For commercial real estate loans, such as those that are secured by large commercial real estate like office buildings or shopping centers, the calculation is: DSCR = Net Operating Income (NOI) divided by Debt Service (Principal + Interest). In contrast to the DSCR Ratio for DSCR Loans, the expenses for the property (such as property taxes, insurance, etc.) are included in the numerator, not the denominator.
- The only expenses taken into account for the DSCR Ratio in DSCR Loans are property taxes, property insurance and if applicable, association dues to an HOA. Thus even if you are planning for more expenses, such as repairs and maintenance or utilities, it is not considered by your DSCR Lender. This is another reason why DSCR Loans are known for easy qualification!
- The DSCR Loan “on paper” (i.e. calculated by your DSCR Lender) will not always be the same as the actual cash flows you experience in real life. In addition to the expenses mentioned above that are not included in the calculation, there are some methodologies that DSCR Lenders follow that may make the calculated DSCR ratio different than the actual cash flow. The main example for this is related to the rental income utilized. DSCR Lenders will use the “lower of in-place and market rent” for the numerator in the DSCR Ratio. This means that the lender will use the lower number of the rent a tenant is paying and the “market rent” of the property, as determined by an appraiser under the 1007 form. So for example, if the property is rented on a 12-month lease at $2,500 per month, but the appraiser determines the market rent for the property is “$2,000” per month, the DSCR Lender will use the $2,000 number as rent.
- DSCR Loans are typically fixed-rate thirty year loans with the same payment every month. However, a popular option for investors is an “interest-only” option. This means that instead of a fixed payment for thirty years, the first ten years of payments are interest-only and require no principal payment. Thus, the monthly “PITIA” payment is lower because the “P” is $0! This is great news for investors using DSCR Loans because the DSCR Ratio uses the interest-only payment to calculate the ratio, even though the payment will be higher after the first ten years of the term.
What documents are required for a DSCR Loan?
DSCR Loans are most well-known for having lighter documentation requirements than conventional loans. While it is true that the paperwork and documentation hurdle is much lighter for DSCR Loans, it is wrong to call them “no doc” loans. That terminology is a carryover from the early 2000s, where extremely light documentation and qualification requirements by mortgage lenders led to the housing crash and recession.
DSCR Loans have become such a popular and successful loan product because they combine the easy and non-burdensome documentation requirements with responsible and reasonable underwriting requirements. DSCR Lenders require a small amount of documents, and use common sense, requiring only what is necessary and reasonable to qualify for the loan.
Documentation Requirements:
- Application – a loan application with basic details on the borrower and property. Typically is a few pages and takes around 15 minutes
- Credit Authorization – a quick authorization form for the lender to run a credit report and background report
- Bank Statements – two months of bank statements showing that 3-6 months of liquid assets for “reserves” are available to cover any debt payments in case of vacancy, turnover, etc.
- Leases – if the property is a long-term rental and is occupied, the lease or leases are to be provided
- Short Term Rental History – if the property is utilized as a short term rental (Airbnb, etc.) and there are 12 months of operating history available (via the booking platform or property manager)
- Insurance – property insurance is required to be provided, with the lender’s information included. If the property is in a federally designated “Flood Zone,” flood insurance is required as well. Note that liability insurance is typically recommended, but not required to be provided by most DSCR Lenders
- Entity Documents – not applicable if you are borrowing as an individual, but required if, like many investors, choose to set up an LLC. For borrowers that go this route, a few documents are typically required. It is often going to depend on the state of incorporation. Typical entity documents required by DSCR lenders include:
- Certificates of Good Standing
- Certificate of Formation
- Articles of Organization and Operating Agreement
- Renovation Documentation – for borrowers that follow the BRRRR method and use 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.
The above list covers the fairly short list of documentation requirements for DSCR Loans. The absence of burdensome items like employment verification and tax returns show why investors love DSCR Loans. The underwriting and document-gathering process is typically much less strenuous and headache-inducing than qualifying for a conventional mortgage!
In addition to the documents provided by the borrower included above, the lender gathers a few other documents as part of the qualification process. Typically, while the lender will order them and manage the process, they pass the costs through to the borrower. Fortunately, these costs are typically fairly low, generally no more than $2,000, which is often less than 1% of the loan amount.
Lender-gathered documents include:
- Credit Report and Background Report – the DSCR lender will run a credit report and background report fairly early in the process to help determine eligibility and rate and terms. Generally, the higher the credit score, the lower rate you will get. Flagged items on the background and credit reports typically would include a history of late payments on other mortgages, foreclosures or bankruptcies, large liens or judgments outstanding or any criminal record. It’s important to note that any of these things may not disqualify you from a DSCR Loan. But it’s extremely important to be upfront and honest with your lender about any flaggable items.
- Appraisal Report – One of the most important documents in the DSCR Loan process is the Appraisal Report. This is a report done by a third-party appraiser to determine the value of the property. For DSCR Loans, the appraiser will also fill out the previously mentioned “1007 Form” that determines the market rent of the property. The methodology for both of these will be primarily from using “comps” of similar properties for both their values and rents. It is important that the borrower pays for the report, retains ownership, and the lender must initiate the order in a process that ensures independence and safeguards against fraud.
- Appraisal Review – In addition to the Appraisal, DSCR Lenders will typically also order an “Appraisal Review.” This is sometimes also called a “Collateral Desktop Analysis” or “Appraisal Desktop Review.” Unlike a full appraisal, in which a licensed appraiser physically visits the property and does a full report, this is a quicker, more streamlined analysis of the appraisal to confirm the value is reasonable and the methodology used by the appraiser was sound. It will also give an opinion of the value of the property as well. Typically, DSCR Lenders require the value opinion of the Appraisal Review to be no more than 10% different than appraised value.
- Title Insurance – As part of closing a DSCR Loan, title insurance is typically required to close the transaction. Title companies are responsible for checking and verifying the ownership of the properties either for a borrower trying to refinance or a seller attempting to sell a property. In addition, they will check for any liens or claims on the property that might interfere with a lender’s rights of foreclosure. Title Insurance refers to the title company insuring that none of these liens or ownership issues exist, and if missed, they will provide compensation against any losses. The borrower typically pays these costs at closing, and they only incur upon successfully completing a transaction.
How to get the Best Rate and Terms for a DSCR Loan
Real Estate investors are often most concerned with getting the best rates and terms on their investment properties. And for good reason. A big part of the equation of maximizing returns on real estate investing is maximizing revenues and minimizing costs, and financing costs (debt payments) are typically the biggest and most important cost for real estate investors. Interest rates paid on loans is obviously the biggest driver of debt costs for DSCR Loans. The lower the interest rate, the lower the interest payment, so its important to get the best rates on these loans.
So, how does an investor using a DSCR Loan get the best rate? There are typically three metrics that lenders use that determine the majority of the interest rate received.
These are:
- DSCR (Debt-Service-Coverage-Ratio)
- LTV (Loan-to-Value Ratio)
- FICO (Credit Score)
Debt Service Coverage Ratio (DSCR) measures the income from the property versus the operating expenses, i.e., how profitable the investment is. Lenders of course like to see higher DSCRs because rents are greater than costs. They should have no problem making debt payments!
Loan to Value Ratio (LTV) compares the loan amount to the value of the property. For DSCR Lenders, a lower LTV is much preferred. This is because the main recourse a lender has in the case a borrower fails to pay back the loan is to foreclose on the property. The lender wants to make sure if it comes to that, they can protect their risk by obtaining a property worth more than the loan amount extended.
FICO (Credit Score) measures the borrower’s personal creditworthiness and history. While DSCR Loans are primarily based on the property, not the individual, this is the one exception. Lenders reward individuals with a higher credit score and a history of payments on other mortgages by offering lower rates.
For more information on how to get the best rates and terms, check out our comprehensive article on the subject featured on BiggerPockets, the internet’s premier website for real estate investors!
DSCR Loans: What Are They And How To Get The Best Terms
However, when conducting your investment analysis, it is essential to consider factors other than just interest rates. For example, many DSCR Lenders will allow you to “buy down the interest rate” by paying points. Points refer to closing fees paid one-time and upfront at close. If you are planning on holding a property for the long haul, like most investors utilizing DSCR Loans, its often a smart call to do this.
A typical example of options includes choosing between a 30-year fixed-rate loan at an interest rate of 7.500% with no “points” or a 30-year fixed-rate loan at an interest rate of 6.500% with 2 “points” paid upfront. The math thus says that you will essentially save 1% of the loan amount per year with lower interest costs. So, if you hold the loan longer than 2 years, then you will end up saving more than the 2% you paid upfront and come out ahead! [Editor’s Note: the financial math is a little more complicated than this example, but the general point holds]
How Prepayment Penalties work for DSCR Loans
A key differentiating feature for DSCR Loans is the option to structure your loan with what’s called a “prepayment penalty.” This refers to the inclusion of a clause in the loan documents that requires the borrower to pay a fee if they pay off or refinance the loan within the first few years of the term. Why would you want your DSCR Loan to have a prepayment penalty? Because if your DSCR loan contains a prepayment penalty, then your rate can generally be significantly lower! Sometimes over 1% or more lower rate, which can generate massive savings.
How come DSCR lenders are willing to give much better rates if there is a prepayment penalty? It ensures the lender that in case market interest rates decline, they can protect their cash flows. Or collect a fee in case of refinance. Its important to note that DSCR Lenders can’t make you pay more if market interest rates increase, since DSCR Loans are generally fixed rate for 30 years!
The most common prepayment structure for DSCR loans is referred to as “Step Down.” Typically, lenders portray this as “5/4/3/2/1” or “3/2/1.” For these examples, the “5/4/3/2/1” means that if you prepay the loan in the first year, the penalty is 5% of loan amount, then 4% if prepaid in year 2, 3% in year 3, etc. After five years, there is no penalty for prepaying the loan early during the last 25 years of the term.
Other structures include fixed fee percentages such as “5/5/5” options. This refers to a 5% penalty for the first three years and no step down. Generally, if you opt for a higher and longer prepayment penalty, the lender will charge you a lower interest rate.
Options to include a prepayment penalty is one of the main differences between DSCR Loans and conventional mortgage loans, which restrict their use. Lowering your rate with a high prepayment penalty is a great strategy for buy-and-hold real estate investors with a long time horizon. For investors planning to hold onto properties for the long-term to build a cash-flowing financial freedom portfolio, DSCR Loans with prepayment penalties are a great option. If you aren’t planning to sell or pay down the loan for years anyway, the penalty will not come into effect and your rate will be lower!
Some final notes on Prepayment Penalties for DSCR Loans. One is that several states have restrictions on prepayment penalties, even for business-purpose investment properties. These typically only apply to DSCR loans used for 1–4-unit properties, and don’t apply if using a Multifamily DSCR Loan for a 5-10 unit or mixed-use property. States that don’t allow prepayment penalties on these residential investment properties include New Mexico, Minnesota and Alaska. Additionally, some states, such as Ohio, don’t allow prepayment penalties on DSCR Loans with loan amounts under a certain amount ($107,633 for 2023).
Prepayment Penalties on DSCR Loans are also much more lenient than ones typical on larger commercial real estate loans, such as CMBS. Many CMBS (commercial-mortgage-backed-securities) will feature provisions such as “lockout periods” where borrowers can’t prepay under any circumstances. Other provisions can include “defeasance” or “yield maintenance.” This requires the borrower to pay essentially all the interest that would accrue anyway over the remaining term to pay early! Luckily, none of these apply to DSCR Loans.
Are DSCR Loans fixed or variable rate?
Trick question, DSCR Loans can be both fixed rate and variable rate. While some lenders will offer 15 or 20-year options (or now in 2023, some even 40 years!), almost all DSCR loans have 30-year terms. The vast majority will be fixed rate meaning that the interest rate is locked in for the full 30 years! This is valuable for real estate investors who are in it for the long haul. With interest rates and debt payment fixed for the long-term, cash flow tends to increase over time. Why? Well, in the US, average rents have increased by 8.85% per year since 1980. So if historical patterns continue, your income can increase every year while the debt costs stay the same!
There are however opportunities for DSCR Loans to have an Adjustable Rate structure. These are typically referred to as “ARMs” (Adjustable Rate Mortgages). Sometimes these are called “Hybrid ARMs” because they have an initial fixed period (such as for five years) before they start adjusting.So, one can consider DSCR ARM loans as a blend of fixed rate and floating rate options.
A typical DSCR Loan with an ARM structure may be referred to as a “5/6 ARM.” This means that the term is still 30-years, the numbers “5” and “6” in this example refer to the interest rate changes. The first number refers to the initial fixed rate period. In a 5/6 ARM, it means that the interest rate remains fixed for the initial five years.The second number refers to how frequently the rate changes. In this case, it means that after the fixed period, the rate “floats” every six months.
Why would an investor choose the ARM option for a DSCR Loan? Since you are taking more risk that your rate will rise (instead of locking it in), you will typically get a lower interest rate to start. It can definitely be a good option for investors that believe rates are likely to be lower in the future. Or for investors that plan on prepaying the mortgage loan within a quicker time frame before the floating period kicks in.
There are many additional nuances and provisions for Hybrid (Fixed to ARM) DSCR Loans. It’s important to understand all the aspects, especially how the rate may change in the future. For more information on this, and some other aspects of DSCR Loans, check our featured article on BiggerPockets on additional ways to minimize your DSCR Loan rate:
DSCR Loans: How To Use Pro Strategies To Save More And Make More
Types of Properties Eligible for DSCR Loans
DSCR Loans are loans secured by residential properties used for business purposes. They fall somewhere in the middle between residential real estate and commercial real estate loans. They are residential in nature in that the property must be residential in nature (tenants live in the unit(s)). But they are commercial loans in the sense that the residential property must be used for a business purpose. This means that the property owner cannot reside in the property; instead, they must rent it out to generate income.
Traditionally, DSCR Loans have been only allowed for residential properties from one to four units. Meaning single family residences, duplexes, triplexes and quadruplexes. In addition, condo units and townhomes tend to be eligible as well. However, in recent years, DSCR Loans have expanded to include residential properties up to as many as ten units! For extensive information about DSCR Loans for multifamily properties in excess of four units, check out our article on BiggerPockets that provides a comprehensive guide on the subject!
Multifamily DSCR Loans: A New High-Impact Loan Option For Real Estate Investors?
The landscape for DSCR Loans is continuing to evolve and grow, with innovative and forward-thinking lenders like Easy Street Capital leading the way. Recently, properties that have a “Mixed Use” designation, or feature both residential and commercial units, have qualified for DSCR Loans. Mixed Use DSCR Loans are typically secured by urban buildings. These will usually have a business on the first floor such as an office, small shop or restaurant. These will then typically have a couple of residential units on the second floor. Right now, these properties can qualify for DSCR Loans as long as the majority of the square footage is residential.
While we expect DSCR Loans to potentially expand to more types of properties, there are a few that are generally not eligible. Here are a few of the property types that are not likely to be DSCR Loan eligible:
Agricultural Properties
Properties with agricultural income-producing activities such as ranches, farms or orchards are generally ineligible. An investment property that has a main house, but also includes stables or barns, is most likely ineligible for DSCR financing. Even if the income and value solely from the house is enough to qualify.
Assisted Living Facilities
DSCR Lenders generally prohibit properties set up for elder care (and the accompanying high and sometimes unpredictable turnover).
Single Room Occupancy Properties
Real estate investors are increasingly drawn to properties rented by the room. This strategy can maximize tenants and increase cash flow. However, there is generally a rule against renting such properties to university students. Tenants under these arrangements can be riskier and less reliable than tenants that rent an entire house.
Still, lenders can usually make DSCR Loans for these properties on an exception basis. Usually, this requirement involves ensuring that the property can be easily converted to use by a single tenant and can provide enough rental income to cash flow if leased to a single tenant.
Log Homes
DSCR Lenders generally prohibit true vacation cabins, such as those in the Smoky Mountains or other rural areas. The distinction between a Log Cabin and a single-family home designed in “log-style” is somewhat of a grey area. Typically, a property that has a log-cabin style, but also features standard infrastructure hooked up to utilities such as HVAC, running water and septic system and similar comparable properties in the area, are eligible for DSCR Loan financing.
Do all DSCR Lenders have the same qualification rules and underwriting guidelines?
No. A great thing about DSCR Loans is that there are different lenders to choose from, and many have slightly different guidelines and qualification rules. “Conventional” lender have to 100.0% strictly follow the guidelines from Fannie Mae and other agencies. DSCR lenders, on the other hand, have customized guidelines and can even grant exceptions in certain cases!
Typically, DSCR lenders will have interest rates, loan terms, and guidelines that are more or less ~90% equivalent. But the differences can be meaningful, especially when DSCR Lenders commit to specializing in serving specific investor niches, such as those that specialize in short term rentals or the BRRRR Method! DSCR Lenders also have the flexibility to make exceptions on a case-by-case basis. Not having to stick to the guidelines 100.0% like conventional lenders is a huge plus. This tends to be incredibly helpful for savvy real estate investors that make their money finding ways to make deals work!
DSCR Loans for Short Term Rentals
In recent years, real estate investors have increasingly turned to short term rentals to maximize returns and cash flow. To find success in this growing industry, investors have found that DSCR Loans are the best Short Term Rental Loans. Since DSCR Lenders have much more flexibility than traditional lenders, newer strategies like short-term rental investing tend to find them as the best fit. Investors looking to scale short term rental portfolios tended to hit a wall with conventional financing, and the limits imposed.
Problems with Conventional Lending Options for Short Term Rentals:
- No ability to borrow with an LLC – many short-term rental owners and operators prefer to operate through an entity, such as a limited liability company. This can help protect the owner from risk. This tends to be important for short term rentals considering the high volume of guests and potential operating issues.
- DTI Qualification – once you get past your first couple short term rentals, it is unlikely that your personal income (debt-to-income ratio) can qualify multiple properties.
- Agency Lending Maximums – conventional lenders (following Fannie Mae guidelines) limit investment properties financed through these loans at 10.
- Conservative Underwriting – Many short-term rental properties earn much more than long-term rentals. However, many traditional lenders only give “credit” for what the property would earn as a long-term rental, and often even less than that!
DSCR Lenders have been able to step in and provide the best solution for short term rental loans. Many DSCR Lenders are short-term rental friendly, not imposing DTI qualification or limits. Typical DSCR Lenders will qualify based on the income the property has earned over the last 12 months. The short-term rental industry has continued to grow and develop. Professional STR investors have needed more flexible solutions from DSCR lenders.
Luckily, the most innovative DSCR Lenders like Easy Street Capital have stepped in! Easy Street Capital is a strong believer in short term rentals. We have pioneered qualification methods to assist real estate investors scaling portfolios of short-term rentals. As a DSCR Lender specializing in short term rental loans, Easy Street Capital is the best DSCR Lender for short term rentals because:
- Allow rents qualification using projections from AirDNA, a provider of rent projections specifically for short term rentals! This allows deals to qualify with more accurate rental income numbers than if trying to qualify with long-term rents. Often, this difference occurs when a DSCR Loan works with a DSCR > 1.00x, and a not-so-friendly DSCR Lender turns down your deal.
- Allows for properties in so-called “tertiary” or vacation markets. DSCR Lenders that aren’t as comfortable or committed to STRs tend to only lend in areas with significant housing stock for long-term rentals, such as larger cities and suburbs. But Easy Street recognizes that some of the best STR investment properties aren’t in these markets. Many investors have seen great success in pure vacation markets such as Outer Banks, North Carolina and Joshua Tree, California. Easy Street is A-OK lending in these markets.
- Allows for new, hybrid strategies such as “medium term rentals.” This is a popular option for real estate investors in 2023. Instead of short term rentals of a few days at a time, medium term rentals (sometimes called “mid-term” rentals) are typically 30-60 days rentals. Savvy investors can also combine the strategies, mostly renting 30-day stays but converting to STR during busy seasons. Easy Street is at the forefront of providing DSCR Loans for this innovative strategy!
As a lending partner, Easy Street Capital aims to be more than just a source of financing. We have a firm grasp on the market and access to data and market trends that we share with our borrowers. Check out this recent article on the best cities for Airbnb investment in 2023! In addition, we are a huge fan of podcasts and published a list of the Best Short Term Rental Podcasts!
DSCR Loans for BRRRR Method Investors
DSCR Loans are often the best option for refinancing for BRRRR Method investors. BRRRR is a popular new real estate investing strategy. It stands for “Buy Rehab Rent Refinance Repeat.” Investors using the BRRRR method buy a property that needs renovations either with cash or by utilizing a hard money loan. Then, after the renovation is complete, instead of “flipping” the property with the fix and flip method, the investor leases out the property and refinances into long-term debt (such as a fixed rate, 30-year loans).
Investors executing the third “R” of the BRRRR Method (refinance) can choose from a variety of loan options. These include bank loans, conventional loans or DSCR Loans. While BRRRR investors have traditionally had many options, everything changed in spring 2023. Fannie Mae, which governs the rules for conventional loans, released Announcement SEL-2023-01. This changed the rules regarding how quickly investors could do a cash-out refinance when doing the BRRRR method. Instead of being able to refinance at six months, they extended the minimum waiting period to a full year! This essentially made conventional loans unworkable for BRRRR, since a key to success with the BRRRR method is quickly refinancing, so you can recoup capital and “repeat.”
However, the good news is that this didn’t affect DSCR Loans! Since DSCR Lenders do not have to follow Fannie guidelines, these changes don’t apply. Instead of waiting a year, you can refinance with a DSCR loan as soon as the rehab is complete! In addition, extra BRRRR-friendly DSCR Lenders like Easy Street Capital go above and beyond for loan offerings for BRRRR Method Investors. Some leading options for Easy Street Capital DSCR BRRRR Method Loans include:
DSCR Loans in 2024 – What to Expect
Moving into 2024 and beyond, we expect to see developments around DSCR Loan options for Medium Term Rentals, Single Room Occupancy, Manufactured Housing, and Mixed Use Properties. As a flexible, investor-friendly loan product, DSCR Loans have historically evolved alongside up and coming investment strategies and market conditions. Especially in the past couple years, market conditions have pushed investors to get even more creative on how they go about ensuring their investment properties cashflow effectively.
Medium Term Rentals
A medium term rental refers to a furnished rental that hosts guest for a duration of 30 days or more. MTRs experienced tremendous growth in popularity in 2023. DSCR Lenders have yet to develop a unique underwriting method solely for MTRs. Additionally, there is an unmet need for the development of a data aggregation platform for MTRs (something similar to AirDNA and STRs). Be on the lookout for a lending solution tailored specifically to this strategy. The development of supplementary tools and service to help support its continued growth.
Single Room Occupancy (SRO) Properties
Single Room Occupancy (SRO) is a strategy where investors rent out their properties, as the name would suggest, by the room rather than rent the entire property out to one tenant. Give the relentless rise of interest rates in the past couple years, many investors turned to this strategy in an effort to cash flow their properties. For example, you could rent out a two-bedroom, one-bathroom SFR to a tenant for $1,200 a month. If you operate the property as an SRO and rent each bedroom for $750, you’re able to increase cashflow by 25%! Despite the objective viability of this strategy, many DSCR Lenders will not lend on these properties even if the investment is solid. The perception is that the tenant mix may be low-quality or risky in some way. As this strategy continues to grow in popularity, lenders may be willing to take the risk.
Manufactured Housing
Most DSCR Lenders out there are not going to lend on manufactured housing or mobile homes. This is mainly due to the perceived risk associated with these properties. The primary way DSCR Lenders mitigate risk is through their ability to foreclose on a property in case of default. While perhaps unlikely, there is the undeniable risk that these manufactured houses can be moved. In the future, DSCR Lenders can develop additional risk mitigants so that they are able to offer DSCR Loan options for this property type. Potential examples include items such as court affidavits restricting movement of a property, or leverage limits. Manufactured Housing was a significant piece of the real estate landscape in 2023.
Mixed Use
Mixed Use Properties have elements of both commercial and residential properties. These properties are typically found in larger cities and will have a commercial unit on the ground floor and residential units on the other stories. When it comes to DSCR Loans for mixed use properties, most lenders require that the subject property be mostly residential in nature. From an underwriting perspective, lenders typically require a majority of both the square footage of the property to be residential as well as the monthly rental income be from residential units. DSCR Loans for these properties have been offered by certain lenders in the past. Market volatility in recent years, however, has made this an increasingly rare loan product. Expect to see an expansion of DSCR Loan offerings for Mixed Use Properties as the market improves.
Frequently Asked Questions about DSCR Loans
What is the minimum loan amount for a DSCR Loan?
The minimum loan amount for DSCR Loans is going to vary by lender. Minimum loan amounts commonly fall in the range of $75,000 to $150,000 for most lenders. Some lenders may go as low as $55,000.
Note: Easy Street Capital’s current minimum loan amount is $75,000 for a DSCR Loan
What is the minimum credit score for a DSCR Loan?
Like minimum loan amount, the minimum credit score for DSCR loans will vary (sometimes widely) by lender. Generally, the strictest lender will have a minimum as high as 680. A few lenders will have minimums as low as 640.
Note: Easy Street Capital is friendly towards borrowers with challenging credit aiming to build back up financially through real estate investing. Our current minimum credit score is 640 for DSCR Loans.
Can I live in a property bought with a DSCR Loan?
No, DSCR Loans have very strict loans that do not allow the borrower to occupy the properties. DSCR Loan documents include a legal affidavit borrowers are required to sign. This attests you don’t live in, nor do they intend to live in the property in the future. This even includes specific units in multi-unit properties. Even if the property has four units, and three of the units are tenant-occupied, the fourth cannot be owner-occupied.
Can A First Time Investor get a DSCR Loan?
Yes, DSCR Loans are generally available to first time investors, but rules will vary by lender. While a few DSCR lenders will not lend to first-timers, most will do so. First time investors can usually expect minor restrictions such as slightly lower leverage, or a higher minimum credit requirement. There are some DSCR lenders – including Easy Street Capital – that have no restrictions at all for beginner investors. This is especially true if the rest of the borrower’s financial profile is strong.
What is the lowest DSCR Loan down payment?
The vast majority of DSCR Lenders will have minimum down payments of 20%. There are a few, however, that may go as little as 15%.
Note: Easy Street Capital’s current minimum down payment is 20%.
Is there a maximum amount of DSCR Loans that you can have?
No, unlike conventional loans which limit to no more than 10 properties at once, DSCR Loans have no maximum. Each loan is qualified based on the property and credit score, not all the borrower’s personal income, expenses and portfolio.
Do properties need to be leased to qualify for a DSCR Loan?
Generally, for DSCR refinance transactions, the borrower must fully lease the property to a tenant. Properties operated as a short term or medium term rental generally require operating history of earning rental income. For multifamily properties, some lenders will allow one or two units to be vacant for a refinance. These vacant units, however, must be “rent-ready.”
For acquisition transactions, DSCR Lenders will universally allow the property to be vacant, but in “turnkey” condition.
Note: Easy Street Capital is one of the few DSCR Lenders that are “AirBnBRRRR” friendly. Meaning, even for cash-out refinances, a lease is not required if the property is operated as a short term rental.
I am not a US Citizen, can I qualify for a DSCR Loan?
This is a question that is going to vary from DSCR Lender to DSCR Lender. One of the challenges with qualifying as a foreign national is the lack of a credit score. Credit is one of the three key metrics for determining qualification, rates, and terms.
In addition, DSCR lenders typically require “reserves” or a few months of PITIA payments in liquid assets (typically cash accounts). Many foreign nationals don’t have these assets stateside and in US dollars. Some DSCR lenders though will allow foreign nationals. This will typically come along with restrictions on LTV (limited to a maximum of generally 65.0% rather than a typical maximum of 80.0% under most DSCR programs). Also a requirement for a US-based bank accounts for reserves.
Finally, its important to note that this applies to true “foreign nationals” that are non-US citizens and living abroad. Both resident aliens and non-resident aliens (“green card” holders) are typically fully eligible for DSCR loans with no LTV restrictions. One of the main advantages of DCR Loans is that it allows borrowers to be entities. Foreign nationals can participate as part of a borrowing entity. However, they would need to have minority ownership interest in the entity. In this instance, it is still do not permit the foreign national to sign the full recourse guaranty.
For example, if you are a foreign national that owns a portion of an LLC or entity alongside US citizens, and your partner owns at least 50% of the entity and signs a full recourse guaranty, you should be able to qualify for a DSCR Loan with no restrictions.
Can I purchase a property with a DSCR Loan and fund the down payment with seller financing or another loan?
Generally, the answer to this question is “No” – pretty much all DSCR Lenders will not allow any other liens securing the investment property you are purchasing or refinancing. Part of the benefits of DSCR Loans is that the lender is only evaluating your credit and the mortgaged property. Global cash flows or DTI (Debt-to-Income ratio) do not factor into the consideration. This means that unsecured debt or mortgage loans on other properties in your portfolio won’t jeopardize financing. However, the DSCR Loan prohibits any additional debt related to the property you are securing.
However, the DSCR Loan prohibits any additional debt related to the property you are securing.
While some DSCR Lenders will categorize everything with a DSCR under 1.00x as “no ratio,” some will separate near-1.00x DSCR Loans, such as loans with DSCRs of between 0.75x and 0.99x as eligible and having ratios. These lenders would then call any DSCR Loan with a DSCR of less than 0.75x as “no ratio.”
How much reserves do you need for a DSCR Loan?
“Reserves” in the context of DSCR Loans refer to liquid assets held by the borrower at closing of the loan. Typically, DSCR lenders will typically require documenting approximately six months of reserves for “PITIA” . This provides the lender with additional comfort that the borrower will be able to afford the monthly payments. Particularly in case of interruptions in cash flow from the property. These interruptions could be vacancies from leasing turnover or slow seasons for vacation or short term rentals. Lender requirements typically range from as little as three months to as much as nine or twelve months. Very large loans or loans with a DSCR less than 1.00x may require additional reserves. In some specific scenarios, like rate-term refinances when lowering monthly payment, reserve requirements may be waived completely.
Can I use my investment or retirement accounts for the reserves requirement?
Yes! Most DSCR lenders allow the use of brokerage accounts (stocks and bonds) and retirement accounts to satisfy the reserves requirement. For such accounts, the lender will typically utilize a “haircut,” meaning they will value the account at 80 to 90% of the overall balance. For example, a DSCR Lender may give you credit for $80,000 in reserves for a 401k retirement account with a portfolio value of $100,000.
Why do DSCR Lenders use this “haircut?” One reason is to account for the higher risk of stocks and bonds versus cash. These values can fluctuate, while cash stays stable. Another reason is to account for the lesser liquidity (or the borrower’s ease of access to the funds). For example, if a borrower needed to actually use retirement funds to pay debt service on a DSCR Loan, they will likely incur time and costs to sell the financial instruments, transfer the money and may be liable for fees.
Can I use Bitcoin or other crypto assets for the reserves requirement?
Generally, most DSCR Lenders will not allow digital assets for reserves requirements. However, this is a space that is still very new and constantly evolving. One bitcoin and crypto-friendly DSCR lender does currently exist!
What is a “No Ratio” DSCR Loan?
A “no ratio” DSCR Loan typically refers to a DSCR Loan in which the DSCR ratio is less than 1. It’s a bit of a misnomer. If the ratio is less than one (0.85x for example), that ratio can be calculated and does exist, but it will still be typically referred to as “no ratio.”
I can qualify for a DSCR Loan if the DSCR is less than 1.00x?? Meaning it has “no ratio” or is underwritten to have negative cash flow each month?
Yes! While a “DSCR Loan” with a “no ratio” DSCR Loan may sound like an oxymoron, it is not an obstacle for qualification for many DSCR Lenders! Many DSCR Lenders that allow for DSCR Loans with a DSCR Ratio under 1.00x typically do still have a minimum ratio. The DSCR Ratio floor for these lenders is usually 0.75x or 0.85x. There are some lenders that will allow true “no ratio” DSCR Loans with no limits, even under 0.75x!
Why would anyone invest in a property with a DSCR ratio under 1.00x if it means losing money every month?
Believe it or not, there are several situations where it makes sense, both for the investor (borrower) and the lender to do deals in which there is a DSCR under 1.00x!
One example is for markets that have really high appreciation due to limited supply, booming growth or other factors. Recent examples would be markets like coastal California, or Austin, Texas. Historically, these markets have earned investors gigantic returns through home price appreciation that far outstripped any minor negative cash flow. However, it is impossible to predict the future. There is no guarantee that those markets will still earn significant appreciation returns to make investing in them overall profitable.
However, from the lender’s perspective, at a low enough leverage point (typically 65.0% LTV or lower), it makes sense lending on sub-1.00x DSCR to borrowers who want to gamble on appreciation. There is a lower likelihood of the lender losing money since a foreclosure would cover the potential loss.
There are other scenarios where sub-1.00x DSCRs “on paper” make sense for the investor. With DSCR Loans, the key feature is their typical 30-year fixed-rate and fully amortizing terms. This ensures that the largest expense associated with your rental property, the monthly debt payment, remains constant. You pay the exact same dollar amount, for three decades. However, market rents typically increase every year. The 30-year period from 1990-2002 saw a staggering 145% increase in rents (from $447 to $1,096)! While taxes and property insurance rates grow as well, the monthly cash flow of a property, held for thirty years and financed with a fixed-rate 30-year DSCR Loan, will massively increase. This is because while rental income goes up, debt stays the same. Investors with long time horizons will likely see great returns, even if they initially experience negative cash flow. This will balance out over time as market rents increase.
Additionally, many real estate investors employ the tried and true strategy of targeting properties with tenants paying below-market rents, and then, after purchasing the property, they increase the rents to market value once the lease expires. DSCR Lenders however, underwrite the DSCR using the lower of in-place rent or market rent. The DSCR on these properties could be negative if rents are well below-market. In this case, these deals make a lot of sense for investors (borrowers) since they typically only need to wait a few months (out of a 360-month term) to re-tenant the property and start cash flowing. This is another example of a DSCR Loan that is only “no ratio” on paper.
The flip side is if a property rents at a rate well above the appraiser-determined “market rent.” The DSCR Lender will still use the lower of in-place rent or market rent. This creates a situation where the underwritten DSCR may be less than 1.00x. But the rent checks hitting your account every month tell a different story!
Finally, there are situations where there are DSCR Lenders that are still extremely cautious when it comes to lending on vacation rentals or short term rentals. A common methodology for these less forward-thinking lenders are to underwrite DSCRs based on the market rent the property would earn as a long-term rental. Even if its optimized for short term stays or in a vacation market dominated by short term rentals. In these cases, the underwritten DSCR may be below 1.00x. But in the real world, the property would earn robust cash flow well in excess of the PITIA costs. Another case of a deal making sense for both parties despite “no ratio.”
BONUS QUESTION: Why is Easy Street Capital the Best DSCR Lender?:
Direct Lender Easy Street Capital is a direct lender meaning we lend our own capital with our own skin in the game. Many DSCR lenders out there are actually intermediaries, collecting a fee to match you with a lender. Some brokerages are quality and are worthwhile and can get you the best terms when shopping. But oftentimes its best to go straight to the source! Specialize in Your Strategy The best way to win in real estate investing is often becoming an expert in a niche or specific focus. Easy Street Capital has tailored DSCR loan programs specifically for Short Term Rental Investors and BRRRR Strategy investors, with the best and most flexible terms for each.- For Short Term Rentals, we qualify income based on AirDNA, lend in all markets (including seasonal and tertiary ones) and offer enhanced pricing for experienced professionals.
- For BRRRR investors, we can do the hard money loan for purchase in-house (not just the DSCR refinance), offer a cash-out of 100% of your proceeds in as little as 3 months and don’t require a long-term lease prior to refi!
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