DSCR investor loans explained

#What a DSCR loan is

Most mortgages qualify you: your income, your debts and your debt-to-income ratio. A DSCR loan qualifies the property. If the expected rent covers the mortgage payment by enough to satisfy the lender, you may not need to show tax returns, pay stubs or a debt-to-income ratio at all. That appeals to investors who own several rentals, whose tax returns show little income after depreciation, or who are self-employed — see mortgages for the self-employed.

DSCR loans aren’t a government program and aren’t bought by Fannie Mae or Freddie Mac. They are made by lenders that keep them or sell them to private investors, so the rules differ from lender to lender.

#How the ratio is calculated

DSCR = monthly rent ÷ monthly PITIA

PITIA is principal and interest plus property taxes, homeowners (landlord) insurance and any HOA or condo dues. The rent is usually the lease amount or the market rent an appraiser estimates for the property, whichever the lender’s rules call for.

A ratio above 1.00 means the rent covers the payment with room to spare; below 1.00 means you would add money each month. The ratio ignores vacancies, repairs, management and utilities, so a property can pass the test and still lose money.

#Business-purpose, non-QM loans

Regulation Z, the federal Truth in Lending rule, does not apply to “an extension of credit primarily for a business, commercial or agricultural purpose” or to credit extended to anyone other than a natural person, such as an LLC (12 CFR 1026.3(a)). The CFPB’s official interpretation adds that credit to buy, improve or maintain rental property that isn’t owner-occupied is deemed to be for business purposes, whatever the number of units.

For a DSCR loan, that has real consequences:

• No ability-to-repay rule and no Qualified Mortgage status. DSCR loans are non-QM, and features restricted on QMs — such as interest-only payments, prepayment penalties or balloon payments — can appear in them.
• Different paperwork. The lender doesn’t have to use the standard Loan Estimate and Closing Disclosure, though many provide similar disclosures. State laws can still apply.
• You certify the purpose. Lenders typically have you sign that you won’t live in the property. You can’t use a DSCR loan for a home you’ll occupy, and misstating occupancy on a loan application is a serious matter.

#Terms vary by lender

There is no standard DSCR product. Each lender sets its own:

• Minimum ratio — some want a cushion above 1.00, some accept lower ratios with a bigger down payment or higher rate.
• Down payment and credit score — usually stricter than for a home you live in.
• Cash reserves — often measured in months of PITIA.
• Rate and fees — priced for the extra risk, with points and prepayment penalties common.
• Property types — some finance short-term rentals or small multifamily buildings, others don’t.

Compare several lenders and get the full terms in writing. A fixed or adjustable rate choice matters as much as on any other loan.

#DSCR vs conventional investment-property loans

Fannie Mae and Freddie Mac also buy loans on investment properties. They qualify you on your personal income, and count only part of the rent.

On the example property, Fannie Mae’s method treats 75% of the $2,400 rent — $1,800 — as net rental income and subtracts the $1,878 PITIA, leaving −$78 a month. A negative figure is added to your debts in the DTI ratio; a positive one can offset the property’s payment or count as income, depending on your experience as a landlord.

If your income is well documented and you have fewer than 10 financed properties, a conventional loan usually costs less. DSCR loans earn their higher price when your tax returns understate your ability to pay, you buy through an entity, or you’ve reached conventional limits.