Finding the ideal rental property is the first step in your real estate journey. You’ll need reliable funding if you want to maximize your return on investment. There are various alternatives for financing a rental property, and you’ll want to obtain the most competitive loan rates and advantageous terms.
So, what choice would be best for you? In this post, we’ll examine DSCR and traditional loans as the top alternatives for obtaining a loan for a rental property to help you make the best possible decision.
What is a DSCR loan?
In short, DSCR loans are underwritten using property-level cash flow instead of personal income. The DSCR reveals whether a property makes enough money to cover the mortgage. When a real estate investor applies for a new loan or refinances an existing mortgage, lenders utilize the debt service coverage ratio as one metric to establish the maximum loan amount. The more net operating income is available to service the debt, the higher the DSCR ratio will be.
What Is a Conventional Loan?
A conventional mortgage is not insured by the government and must adhere to rules established by Fannie Mae and Freddie Mac. A conventional mortgage requires a minimum payment of 3% of the purchase price. However, depending on your credit rating or debt-to-income ratio, the lender can demand a higher down payment.
DSCR Rental Loans vs. Conventional Loans: Which One to Choose?
If you’re wondering which of these two loan options is best for you, consider the main differences between the two.
DSCR Lenders Don’t Consider Personal Income
A DSCR loan does not need employment verification, lease disclosure, or income documentation. The lender is only concerned with the cash flow produced by the subject property.
When applying for a conventional loan, however, the borrower’s details, including credit history and score, will decide if they are approved and what interest rate they will pay. Traditional lenders also examine borrowers’ assets and income, which necessitates a significant amount of paperwork and time on the borrower’s part.
DSCR Has Quicker Closing Times
The process of applying for a conventional loan can be daunting and typically takes 30 days or longer due to the legal scrutiny your loan must undergo.
The DSCR procedure omits the stages that loan processors and underwriters usually take, such as looking over your paystubs and checking your job history. In comparison to conventional loans, this leads to a quicker closing.
DSCR Loans Allow You to Commit to Several Properties at Once
With traditional loans, there is a limit on the maximum number of conventional loans that real estate investors can hold. The current cap has been increased to 10 loans. Keep in mind that lenders could be reluctant to let you obtain multiple mortgages simultaneously. Additionally, you might have to meet greater credit score, cash reserve, and down payment requirements. You might also have to cope with rising mortgage interest rates if you own several houses.
DSCR loans don’t operate that way. If you want to develop your rental business quicker, you can concurrently take out multiple loans for various assets.
Traditional Loans Have Longer Terms
Getting a loan from a traditional lender will likely have a long duration, up to 30 years. If you take a standard fixed-rate mortgage, you’ll pay fixed monthly principal and interest payments for the duration of the loan.
The terms for a DSCR loan are 5 to 25 years, with 15 or 20 years being the most typical. The lender would often choose the loan’s duration based on the sort of property being bought and the anticipated cash flow of the firm, among other factors.
Traditional Loans Have Lower Interest Rates
There is no doubt that conventional loans feature some of the best interest rates available for long-term financing of real estate. For instance, the interest rate for a 30-year fixed loan is nearly 6.3%.
To compare it, the current DSCR rates range from 7.52% on the low end to 8.97% on the high end, assuming a 30-year fixed loan with a 25% DSCR down payment and a 1.2 DSCR ratio.
Final Thoughts
You need to have the right financing set up to embark on a profitable real estate journey. Even though there are many different kinds of loans for rental investment properties, it’s essential to know your options because picking the wrong one could prevent you from finalizing the sale. Hopefully, this article has shed light on the main differences between DSCR and conventional loans for real estate investments and has helped you decide on the best option for you.
