Choosing the right type of loan is important for real estate investors aiming to grow their real estate portfolios. Two popular loan options are DSCR (Debt Service Coverage Ratio) loans and conventional loans. Understanding the differences between these loans can help you make an informed decision that aligns with your investment goals.

What is a DSCR Loan?

A DSCR loan is a type of financing that evaluates the ability of a property to cover its debt obligations through its monthly income.

The Debt Service Coverage Ratio (DSCR) is calculated by dividing the monthly rent of the property by the monthly loan payment (principal + Interest), taxes, insurance and association fees (PITIA).

DSCR = Rent/PITIA

The basis of a DSCR loan is that the rent you collect from tenants leasing the property should be greater than the cost to own and operate the property.

Investment purpose rental properties with a DSCR loans greater than 1.0 are called “cash flowing”. You’ll need a cash flowing property to obtain a DSCR loan (read more here).

What is a Conventional Loan?

Conventional loans are traditional mortgages not backed by government agencies. They are used for primary residences and sometimes investment properties. To qualify for a conventional loan, borrowers must meet specific requirements pertaining to verified income, a debt-to-income ratio not greater than 0.4, and a sufficient down payment.

Key Differences Between DSCR Loans and Conventional Loans

Purpose and Property Type

• DSCR Loans: Designed primarily for rental properties and income-generating real estate. They focus on the property's ability to generate income rather than the borrower's personal income.
• Conventional Loans: Used for primary residences and certain investment properties. They are based on the borrower's income based financial situation.

Approval Criteria

• DSCR Loans: Approval is based on the property’s income generation, with no dependency on the borrower’s personal income.
• Conventional Loans: Approval is based on the borrower’s income verification and debt-to-income ratio (must not exceed 0.4).

Interest Rates

• DSCR Loans: Have higher interest rates, typically only about 0.5%-1% higher than conventional loans.
• Conventional Loans: Require a lower down payment and offer lower interest rates.

Loan Terms and Closing Speed

• DSCR Loans: Offer flexible terms and a faster closing process.
• Conventional Loans: Slower closing process than is usually not fast enough for the competitive investment property market.

Who Should Use DSCR Loans?

• Real Estate Investors: Ideal for those focused on rental properties and looking to build their portfolio beyond their income-based creditworthiness.
• Credit Preservation: Suitable for investors who do not want to max out their personal creditworthiness.
• Speed: Beneficial for investors needing a faster closing process.
• LLC or Corporation: Allows for closing loans under an LLC or corporation, providing additional protection and potential tax benefits.

I’m Qualified for a Conventional Loan on My Investment Property. Should I Still Use a DSCR Loan?

Even if you qualify for a conventional loan, a DSCR loan may still be advantageous. Holding an investment property in an LLC offers liability protection and can be beneficial for tax purposes. Additionally, using a DSCR loan preserves your personal creditworthiness, which is important if you plan to upgrade or buy a second personal residence. With DSCR loans typically having interest rates less than 1% higher than conventional loans, the benefits usually outweigh the slightly higher cost.

Get Qualified for a DSCR Loan with Ridge Street Capital

At Ridge Street, we specialize in providing DSCR loans to real estate investors. Our streamlined process and expert guidance ensure you get the financing you need quickly and efficiently.

Request a Term Sheet | Get Pre-Approved | Schedule A Call