Alternative financing solutions are essential for real estate investors in today’s market.

One of the most popular options is the debt service coverage ratio (DSCR) loan, which is primarily focused on the property’s income rather than your own.

This factor alone allows investors who cannot easily qualify for a traditional loan the opportunity to purchase a rental property and start generating income.

For experienced real estate investors, a DSCR loan isn’t considered an “alternative”; it’s an indispensable loan option.

Let’s dig into how the current market trends have popularized crucial lending solutions such as DSCR loans for investors.

What is a DSCR loan?

A DSCR loan is focused on a rental property’s expected cash flow rather than a borrower’s income and employment.

The debt service coverage ratio equals your net operating income divided by your debt obligations.

For example, if your debt obligations total $2,000 per month and your net operating income is $3,000 per month, your DSCR would equal 1.5.

A DSCR of 1.25 or higher is considered strong. Some lenders may allow a DSCR as low as 1.0, but higher is better for unlocking the most favorable loan options.

Why are DSCR loans trending in today’s market?

Today’s market conditions include high interest rates, high home prices and low inventory, which, added together, make securing financing more difficult for the majority of borrowers.

DSCR loans are a popular option in today’s market because they provide investors with more flexibility in most cases, including but not limited to:

• No income documentation required
• No limit to the number of rental properties you can finance
• Higher loan limits
• The possibility of structuring the loan for an LLC (a limited liability company)

A traditional loan requires borrowers to provide extensive income documentation, including tax returns, W-2s and pay stubs.

Many types of borrowers are unable to satisfy these requirements, especially if they are self-employed or full-time investors.

Rather than depending on the usual documentation, a DSCR loan is underwritten based on the property’s projected income, a strong DSCR and good credit.

Because approval is largely focused on the investment property, more borrowers are able to qualify as long as they bring a solid deal to the table.

Where is the real estate market headed?

Conventional loan requirements have become increasingly difficult to meet for the average investor in today’s market.

While the current market’s challenges may be unique in comparison to the pre-pandemic market, the market’s general ebbs and flows are not unusual.

Regardless of where the market heads next—whether it be lower interest rates and home prices or a dramatic increase in inventory—DSCR loans will remain a more flexible option for investors and those with alternative sources of income.

This type of loan also has competitive interest rates which borrowers can influence with a strong DSCR, credit score and more.

Which types of borrowers would benefit from a DSCR loan?

DSCR loans are suitable for a range of borrowers and property types, including:

• Real estate investors
• Self-employed individuals
• Freelancers or contract workers
• Business owners
• Single-family and multifamily property owners
• First-time investors
• Seasoned investors

DSCR loans are ideal for borrowers who have difficulty proving their income with traditional documentation such as pay stubs and tax returns.

Lenders understand that the strength and validity of a deal rely on more than just personal income.

Because this type of lending is specifically designed for scenarios where the primary source of repayment will come from the property’s income, DSCR lenders consider a range of factors beyond personal income to evaluate the viability of a deal.

How can borrowers qualify for a DSCR loan?

DSCR loans are for income-generating properties only and can be used for single-family or multifamily properties.

You can typically expect to see the following requirements from a DSCR lender:

• DSCR of 1.0 or higher
• Credit score of at least 620
• Down payment of 20-25%
• Loan amounts of no more than $5 million
• Long-term and short-term rentals
• Property appraisal
• Borrowers can close as individuals, LLCs, corporations or other entities

To start the DSCR loan process, find a reputable lender to apply with, such as Compass Mortgage.

The lender will request a credit report (from one of the national credit bureaus) and may ask you for the following documentation:

• Bank statements
• Property insurance
• Lease agreements for existing tenants and rental rates (if applicable)
• Income and expense projections
• Short-term rental history
• Proof of property insurance
• If an LLC, entity documents (as filed with the state where the LLC is registered)
• Business plan and exit strategy

It’s crucial to work closely with your DSCR lender to ensure you understand the requirements and are able to supply all documentation.

How do you find a lender who offers DSCR loans?

DSCR loans are popular in today’s market, and this means it is easier than ever to find a lender who offers this type of loan.

However, not all DSCR lenders are the same. One key component of a successful DSCR loan process is a strong partnership with your lender.

The relationship between a lender and borrower requires the following characteristics:

• Open communication
• Transparency
• Trust
• Credibility

These characteristics are instrumental in moving along the loan process, ensuring a mutual understanding, accessing the most favorable terms and solving unexpected issues or challenges.

It can also lead to repeat business for many years of profitable deals to come.

Apply for a DSCR loan today with Compass Mortgage

Compass Mortgage was founded on the core values of excellence, integrity and the infinite worth of people.

We are your advocate and partner throughout every step of the loan process, backed by the convenience and power of innovative technology designed for the mortgage industry.

To start the DSCR loan process, apply now.

We’ll ask for information about the property you want to purchase so we can provide personalized options and solutions.

If you’re new to the process or want to learn more about Compass Mortgage’s requirements and DSCR loan process, contact us here or give us a call at (877) 677-0609.

Compass Mortgage is “Home to a Better Mortgage Experience” because we believe our corporate culture, work ethic and end results set us apart.

We can’t wait to work with you and help you meet your investment goals.