Debt Service Coverage Ratio (DSCR) loans skip personal income verification, allow financing of multiple properties, and close faster than traditional mortgages, offering flexibility and ease of transaction.
However, they come with higher interest rates, fees, and down payments.
Keep reading to understand the pros and cons of a DSCR loan in Texas and determine whether it fits your investment strategy and financial goals.
Designed for real estate investors, a DSCR loan focuses on an investment property’s debt service coverage ratio instead of your personal income.
Lenders review DSCR to see whether the investment property earns enough to pay its mortgage. Loan approval and terms heavily rely on the property’s cash flow.
They calculate DSCR as the property’s net operating income (NOI) divided by its total annual debt service (including all debt obligations).
DSCR loans apply only to income-generating properties, not owner-occupied primary residences. Also, the property must be renter-ready, so fixer-uppers don’t qualify.
Key Takeaway: Lenders use DSCR to evaluate your ability to repay the debt through rental income without checking your personal earnings.
DSCR loans are easily accessible to first-time and seasoned real estate investors in the United States.
RentRedi cofounder and CEO Ryan Barone notes that limited income or unsteady employment often prevents aspiring investors from securing conventional loans.
In these cases, DSCR loans are an excellent financing solution.
They offer these advantages:
Because approval depends on strong cash flow from the property, you don’t have to worry about the lender verifying your pay stubs, W-2s, or employment history. You also skip the hassle of providing piles of paperwork.
Most lenders will only ask for your bank statements to verify your reserves.
DSCR loans are a smart fit for:
Unlike conforming traditional loans, which cap you at 10 single-family (1-to-4-unit) properties under Fannie Mae and Freddie Mac guidelines, DSCR loans let you finance as many income-earning properties as your cash flow supports.
Also, you can refinance your loan once it gains sufficient equity, so you can use the cash to buy more rental property.
Expand your portfolio even without paying down a previous loan, so growth never stops.
Scale from a single rental to a whole portfolio, including:
Approval moves from application to closing faster than traditional mortgages because the decision depends on the property’s DSCR rather than your personal finances.
Key Takeaway: DSCR loans simplify the application process for borrowers with complex or limited income and investors wanting to expand their portfolios. With the right ratio, lenders green-light loans so you don’t have to deal with lengthy income audits.
Here are the drawbacks of DSCR loans:
Unlike conventional loans, which require down payments as low as 3%, most DSCR loans require a 20% to 25% down payment to reduce the risk. This can be challenging for investors who don’t have enough available funds.
Lenders may request a higher down payment (up to 30%) if the property has a weak DSCR or the borrower has a low credit score.
DSCR loans often have higher mortgage interest rates and fees (underwriting, origination, and processing fees) than traditional loans, making financing more costly.
Interest rates range from 6.5% to 8.5%, roughly 1 to 2 percentage points above a conventional investment-property mortgage. Terms may be less favorable for borrowers with low credit scores.
Also, some lenders may charge prepayment penalties if you want to pay your loan early, as DSCR loans aren’t government-backed.
Pro Tip: Aim for a 740+ credit score and a strong DSCR to get the best loan terms. Review the terms of your loan agreement extensively to ensure you don’t miss crucial details like prepayment penalties.
Conventional loans allow up to 97% LTV. On the other hand, lenders offering DSCR loan programs usually approve 75% to 80% loan-to-value (LTV) with a qualifying DSCR.
That means you must pay the remaining amount as the down payment.
If the property income isn’t enough, you could fail to pay your monthly mortgage, leading to foreclosure.
When this happens, you’ll lose your property and impact your financial standing.
Be sure to select properties with strong income-generation potential that meet lender requirements. Stay on top of property demand and market trends in Texas for a successful DSCR loan.
A DSCR loan is an excellent investment tool when you focus on properties with a strong cash flow.
It’s ideal for real estate investors who want less documentation and a smoother approval process, especially those who don’t qualify for traditional loans. Just make sure you have enough money to cover the down payment.
Take time to compare the pros and cons of a DSCR loan in Texas to make the right financial decision.
Need help deciding? Our mortgage experts are ready to help you choose the best financing option for your financial goals.
Reach out to us today to explore your options!