Choosing between a debt service coverage ratio (DSCR) loan versus a conventional loan can directly affect your level of success as an investor.
Each differs in eligibility criteria, closing and funding speeds, and flexibility with loan terms. These factors directly impact how competitive your offers are, as well as how quickly you can scale a portfolio.
This guide compares DSCR and conventional loans from the perspective of a property investor. It emphasizes critical factors, such as underwriting flexibility, scalability, and real-world scenarios.
Key Takeaways
- DSCR loans are qualified based on the property, not the borrower. Investors who cannot qualify based on personal income may still qualify using the property’s cash flow.
- Conventional loans can limit growth. Many conventional loans cap the number of financed properties, making it difficult for investors to build a larger portfolio.
- Approval and funding speeds matter in competitive markets. DSCR loans typically close more quickly, reducing the likelihood of missing out on a good investment deal.
What Is a DSCR Loan?
In financing investment real estate, a DSCR loan evaluates the property’s cash flow rather than the investor’s personal income. DSCR is a financial figure that measures whether a property can generate sufficient income to cover its monthly debt obligation.
In addition to a property’s rental income, DSCR loans consider its operating expenses and proposed loan payment. Lenders can use this information to determine if the property is an acceptable risk and meets their guidelines.
This flexibility often appeals to investors who may otherwise be ineligible for conventional financing, which reviews personal income and debts to determine the ability to repay the debt.
For a detailed overview, see our guide covering what a DSCR loan is.
How DSCR Is Calculated
Lenders use a property’s DSCR ratio to measure whether its expected rental income can fully cover its debt payments. Lenders generally view properties with higher DSCR ratios more favorably.
Here is a basic DSCR formula:
DSCR = Monthly rental income ÷ monthly debt obligations
A ratio of 1.0 means the property should break even, with rental income being exactly equal to debt payments. Higher ratios indicate the property will have a positive cash flow. You can determine your own DSCR ratio with LendingOne’s DSCR calculator.
Pros and Cons of DSCR Loans
DSCR loans won’t be for everyone. Consider the following pros and cons to help decide whether it’s right for you:
Pros
- Does not require personal income: Lenders base approval on the property’s ability to generate rental income rather than on your personal income and debt.
- Well-suited for portfolio investors: Conventional loans have less flexibility in terms and qualification requirements, making DSCR loans more investor-friendly.
- Faster approval and funding speeds: DSCR lenders are often well-versed in the nuances of investment loans, allowing them to fund and close more quickly.
Cons
- Higher interest rates: More costly pricing is a reflection of the increased underwriting and loan term flexibilities. Learn more about how DSCR loan interest rates are determined.
- Larger down payment requirements: From a risk management perspective, and to balance increased underwriting and loan term flexibilities, many lenders require larger upfront down payments.
What Is a Conventional Loan?
A conventional loan is a mortgage typically offered by banks and credit unions. These loans are often issued based on a borrower’s personal income and debts.
Common underwriting requirements involve an evaluation of a borrower’s income, employment history, credit score, and debt levels. In other words, lenders determine a borrower’s ability to repay a loan based on personal factors, rather than the property’s ability to generate income.
Compared to DSCR financing, conventional loans have some notable limitations. For instance, many programs and lenders have a cap on how many financed properties a borrower can have.
Paperwork requirements are also generally more extensive, leading to a more time-consuming process for approval and funding. Conventional loans also do not typically have as much flexibility for underwriting or available loan terms.
Pros and Cons of Conventional Loans
Just like with DSCR loans, conventional loans also have their own set of pros and cons. Below are some of the key factors that should be considered for conventional financing.
Pros
- Lower interest rates: Conventional loans often carry lower rates due to lower perceived risk from higher paperwork requirements and strict underwriting methods.
- Smaller down payment requirements: Down payment requirements tend to be smaller, which can be beneficial for investors strapped for cash.
Cons
- Strict income and documentation requirements: Lenders depend on documented stable income, employment, and low debt levels for approvals, which can be difficult for investors.
- Limits on the number of financed properties: Conventional lenders typically cap the number of properties an investor can have as a requirement for loan approval.
- Less flexibility for portfolio investors: Compared to DSCR loans, underwriting and loan term flexibility is significantly lower, which can hinder an investor’s ability to scale quickly.
DSCR Loan vs. Conventional Loan at a Glance
Borrowers can use either a DSCR or a conventional loan to finance investment properties. However, each has notable differences in things like qualification requirements, funding speeds, and other nuances that can impact portfolio growth.
| DSCR Loan | Conventional Loan | |
| Primary Qualification | Property cash flow (DSCR) | Borrower income and DTI |
| Income Documentation | Not required | Required (W-2s, tax returns, paystubs) |
| Debt-to-Income Ratio | Not applicable | Strict DTI limits apply |
| Underwriting Focus | Rental income versus debt payments | Personal income, employment, and credit |
| Eligible Properties | Non-owner-occupied investment properties | Primary residences and limited investment use |
| Ownership Structure | Can close under an LLC | Typically must close personally |
| Portfolio Scalability | Designed for multiple properties | Loan count limits restrict scaling |
| Speed to Close | Faster, streamlined process | Slower bank-driven timelines |
| Flexibility for Self-Employed Borrowers | High | Low to moderate |
| Use Case | Rental acquisitions, refinances, BRRRR strategies | Long-term holds with high personal income |
| Ideal Investor Profile | Investors focused on growth and cash flow | Investors prioritizing rate over flexibility |
Qualification and Underwriting
By evaluating a property’s cash flow to determine eligibility, DSCR loans give investors more flexibility to qualify and expand their portfolios more quickly.
Conventional loans, however, evaluate an investor’s sources of personal income and debt levels to determine their ability to repay the loan.
Scalability and Portfolio Growth
Conventional loans often have requirements that limit how many financed properties a borrower can have. If a borrower exceeds that limit, a conventional lender will not issue additional financing.
DSCR loans typically don’t impose the same limits. This makes DSCR loans more suitable for investors looking to grow and scale a portfolio of rental properties.
Speed and Certainty of Closing
Conventional loans often have slower funding timelines, in part because the loans are more often used for primary and secondary residence financing. In other words, conventional lenders may not be privy to the nuances and urgency of funding needed for investors.
DSCR loans, by contrast, often cater to real estate investors. Since these lenders have a greater understanding of the importance of timely funding, DSCR lenders can often fund and close more quickly and consistently.
Ownership Structure and Liability
DSCR loans have more flexibility in allowing borrowers to close loans in the name of an LLC or corporation. Doing so affords more protection for an investor’s personal assets.
Conventional loans often require loans to be closed under a borrower’s personal name, which can result in personal financial liability.
Down Payment Requirements
DSCR loans can require down payments ranging from 20% to 30% or more. Payments depend on the property’s characteristics, deal complexity, and overall strength of the loan application.
Conventional loans can have far lower down payment requirements of around 10% or less, depending on the details of the loan.
Credit Score Requirements
DSCR loans typically require a minimum credit score of 650 or higher. However, many lenders offer a degree of flexibility depending on the strength of compensating factors you may have, such as a larger down payment.
Conventional loans can have requirements as low as 620. Credit score requirements can depend on things like property type and occupancy, but they have little to no flexibility.
Interest Rates and Fees
DSCR loans typically carry higher rates due to the added risk of the flexibility in underwriting and loan terms.
Conventional loans usually have lower rates. However, they may have additional fees, such as loan-level pricing adjustments and points, that are tied to loan characteristics.
Property Eligibility
DSCR lenders design these loans for rental properties, including single-family homes, townhomes, condominiums, and multi-unit properties.
Conventional lenders typically use these loans for primary and secondary residences, with some flexibility for investment property usage. For this reason, many investors find DSCR loans to be a better fit for expanding a portfolio of rental properties.
When a DSCR Loan Is the Better Fit
DSCR loans are often a strong fit for investors who:
- Want to build and grow a portfolio of rental properties without worrying about limitations on personal income or the number of financed properties.
- Have income or employment that can be difficult to document or is particularly complex.
- Are using BRRRR and fix-to-rent as a rental portfolio strategy.
Ultimately, investors looking for speed, flexibility, and expertise in partnering with a lender typically find DSCR loans to be more ideal.
When a Conventional Loan May Make Sense
While DSCR loans may be well-suited for a majority of investors, conventional loans can still make sense in several scenarios for investors who:
- Have a smaller portfolio of properties and who won’t have to worry about running into loan limitations.
- Have high personal income and easily documentable employment.
- Are cost-conscious and can benefit from more competitive rates for long-term holds.
Investors who prioritize lower rates, stable income qualification, and long-term holds over portfolio scalability and underwriting flexibility will find that a conventional loan meets their needs.
Why Real Estate Investors Choose LendingOne DSCR Loans
Seasoned investors know that the best fix-and-flip lenders aren’t always the ones with the lowest interest rate. The right loan needs to align with the investor’s strategy, as different lenders and loan programs offer varying levels of speed, flexibility, and predictability in the underwriting and funding processes.
LendingOne designs its DSCR loans to support investors throughout the entire process. Investors can use these loans as a repeatable tool for long-term portfolio growth, rather than a one-time transaction. With that being said, LendingOne focuses on being a true strategic partner and not just a source for capital.
Learn more about LendingOne’s DSCR loans, or see your rate today.
FAQs About Choosing Between a DSCR and a Conventional Loan
Can I refinance a conventional loan into a DSCR loan later?
Yes, if property meets DSCR requirements. Many investors start with conventional loans, only to later refinance into a DSCR loan once the property has stabilized or rents have increased to meet DSCR requirements. Doing so removes some of the restrictions of conventional loans, such as the cap on the number of financed properties.
Do DSCR loans work for short-term rentals or Airbnb properties?
Yes. However, lenders determine eligibility based on their specific guidelines and local market conditions. They also require reliable market data or operating history to support the projected income.
What happens if my DSCR is below 1.0?
A DSCR ratio below 1.0 means that the rental income generated by a property will not be enough to cover the property’s debt obligation amount. Lenders each have varying thresholds for DSCR ratios, so it’s still possible to get approved below 1.0.
Are DSCR loan rates always higher than conventional rates?
In most cases, DSCR loan rates will be higher than conventional rates. However, this can depend on the property characteristics and the strength of the loan application.
Despite the higher rates, many investors still choose DSCR loans due to the increased flexibility and ability to close more quickly.
H3: Can I use projected rents instead of current leases?
In many cases, yes. DSCR lenders can use projected rents if supported by market appraisals of typical rent amounts.
This approach is more common for BRRRR and fix-to-rent properties. In these investments, recent property improvements might not yet reflect the new true market rent potential.
