DSCR loan pros and cons that every investor should know

If you’re looking to finance a rental property but don’t qualify for traditional loans, a DSCR loan could be a smart alternative — especially if you’re a real estate investor focused on cash flow rather than personal income.

Before moving forward, however,  it’s important to weigh the pros and cons. In this article, we’ll break down how DSCR loans work, what’s required to qualify, and the key benefits and potential drawbacks. We’ll also explore alternative funding options in case a DSCR loan isn’t the right fit for your investment goals.

How a DSCR loan works 

DSCR stands for Debt Service Coverage Ratio. Real estate investors use DSCR loans to purchase rental properties that generate income, usually in the form of rent payments on commercial buildings or individual properties.

DSCR is the key calculation lenders use to decide whether to approve a loan for a real estate investor. It helps determine if a property generates enough income to cover its debt obligations. You can calculate DSCR using a simple formula: divide your property’s net operating income (NOI) by its annual debt service (ADS). Many online DSCR calculators can also help you quickly run the numbers.

Don’t forget to include the principal, interest, taxes, insurance, and HOA fees on the property. A DSCR lender will need to know all of the operating costs and debt obligations tied to the property to evaluate eligibility.

DSCR calculation example

Let’s say you want to purchase an investment property with a mortgage of $18,000 per year (or $1,500 per month). You plan to rent out the home for $24,000 per year (or $2,000 per month).

Using the formula of DSCR = NOI/ADS, you’ll divide 24,000 (the net operating income) by 18,000 (the annual debt or mortgage payment of the home). That gives you a DSCR of 1.33. According to Inrev, a DSCR >1 means a property has positive cash flow. 

Lenders have varying DSCR requirements. For example, the U.S. Department of Agriculture (USDA) ReConnect program requires a minimum DSCR of 1.2 for investors to qualify for loans and grants.

DSCR loan requirements

Requirements can vary by lender, but here are some common criteria borrowers typically need to meet to qualify for a DSCR loan:

• Most lenders require a minimum DSCR between 0.75 and 1.2, depending on their risk tolerance.
• Borrowers typically need to provide a down payment of 20% to 25%.
• A minimum credit score of 620 is often required, though some lenders may set the bar higher.
• Lenders will usually require a property appraisal to confirm the property’s market value.
• You’ll need to prove that the property generates rental income, as this is key to DSCR loan approval.
• Only certain property types are eligible, such as single-family homes, duplexes, multi-family homes, or commercial properties — subject to lender approval.
• The minimum loan amount generally ranges from $100,000 to $175,000, though this can vary by lender.
• New investors may face different requirements than experienced investors, with some lenders offering more favorable terms to those with a proven track record.

When getting started, it’s always a good idea to shop for quotes from at least three to five lenders before you apply for a DSCR loan. This will help you find more favorable terms.

DSCR loan pros and cons

Here are the benefits and drawbacks of a DSCR loan that real estate investors should consider 

Pros of a DSCR loan

• Less stringent loan terms: DSCR loans do not have the same strict terms and requirements as traditional mortgages. You can qualify for a DSCR loan if your rental property meets the requirements, even if you might not qualify for a conventional loan.
• Quick approval process and funding: Conventional mortgages can take some time to secure because your lender will have to evaluate your finances, confirm your income, and look through your credit reports. DSCR loans typically have quicker turnaround times.
• Maintain cash levels: Although DSCR loans require down payments, using a loan instead of buying a property in cash allows investors to keep more of their own capital while still generating cash flow from an investment property.
• No limit on the number of properties you can finance: As long as your property meets the requirements, it’s possible to take out several DSCR loans as you build your investment property portfolio.

Cons of a DSCR loan

• Large down payment required: DSCR loan borrowers must put down 20% or more as a down payment on the loan. This is more than conventional mortgages, which have options to put down as little as 0%, depending on the loan type.
• Higher cost: DSCR loans have higher interest rates than conventional loans, as well as additional fees. DSCR loans are considered riskier investments for lenders, so the interest rates and fees lenders charge reflect that.
• Can’t borrow small amounts: Typically, DSCR loans must be a minimum of $100,000, depending on the lender. That means that investors who want to focus on borrowing smaller amounts won’t qualify.
• Rental properties only: DSCR loans are only for income-generating properties. You cannot leverage them for a vacation property or for personal use.
• Vacancy considerations: An investor has to consider potential vacancies. Most rental properties have turnover, and the loss of rental income can make it challenging to make payments.

When does getting a DSCR loan make sense?

A DSCR loan is worth exploring if:

• You don’t qualify for traditional financing: If you have a high DTI ratio, poor credit, or irregular income, you might not qualify for a conventional loan, making a DSCR loan an attractive option.
• You’re investing in properties with strong rental income: Since a DSCR loan is based on your property’s rental income potential, you’re likely to get approved for financing.
• You want to expand into commercial real estate: DSCR loans are also useful for investors who want to expand a real estate portfolio. Investments like commercial real estate or apartment buildings with rental income can benefit from a DSCR loan.

When doesn’t getting a DSCR loan make sense?

You may want to consider alternatives if: 

• Your property has unstable income or high vacancy risk: If the rental income is unpredictable or the property is likely to sit vacant for long periods, qualifying for a DSCR loan—and managing the payments—could be challenging.
• You qualify for traditional financing with better terms: If you have strong credit, a low debt-to-income ratio, and steady income, you may be eligible for a conventional mortgage with lower rates and fees.
• The property is in a developing or volatile market: If you're investing in an area with unproven or fluctuating rental demand, a DSCR loan may carry more risk than it’s worth.

DSCR loan alternatives

If you’re not sure whether or not a DSCR loan is the right option for you, there are a few alternatives to consider.

Bank loans

A traditional bank loan, like a personal loan or conventional mortgage, has stricter qualification requirements than DSCR loans. Additionally, bank loans tend to take longer to get because the process is more involved. However, bank loans also have lower interest rates and lower down payment requirements than DSCR loans.

Bridge loans

Bridge loans are short-term financing tools that help investors “bridge” the gap between purchasing a new property and securing long-term financing or selling another asset. They’re often used by real estate investors who need fast funding to close a deal before their permanent financing is in place.

Bridge loans typically have higher interest rates and shorter repayment terms—usually six months to a year. However, they can offer quick access to capital without the same income documentation required by DSCR or traditional loans. They're best suited for experienced investors with a clear exit strategy, such as refinancing or selling the property.

While bridge loans can be a valuable tool for seizing investment opportunities, they come with higher costs and risks. If the exit strategy falls through, repayment can become challenging.

Home equity loans

A home equity loan allows you to borrow a lump sum against the equity in a primary or investment property. You’ll repay it over a 5 to 10-year term with fixed monthly payments, typically at a lower interest rate than a DSCR loan. 

This option can be useful for funding real estate investments or other large expenses. However, qualification often depends on your credit score, debt-to-income ratio, and income stability. Keep in mind: if you fall behind on payments, your home could be at risk of foreclosure.

Home equity lines of credit (HELOCs)

A HELOC is a revolving line of credit secured by home equity, whether your primary residence or an existing investment property. It works much like a credit card — you can borrow as needed during the draw period and repay over time. HELOCs usually offer variable interest rates and may come with flexible repayment options. 

Like home equity loans, they typically have lower rates than DSCR loans but come with similar risks.

Home equity investment (HEI)

You can also tap the equity in your primary home or rental property with a home equity investment (HEI). HEIs offer a lump sum payout in exchange for a slice of your home's future appreciation. There are no monthly payments; rather, the investment gets paid anytime during a flexible 30-year term when you sell, refinance, or use another source of funds. 

To qualify, you need sufficient equity and a credit score above 500. Income is not a factor with HEIs.

Final thoughts

DSCR loans offer a flexible financing option for real estate investors who may not qualify for traditional mortgages. They’re ideal for borrowers with strong rental income but less conventional financial profiles. However, like any loan, they come with trade-offs—higher interest rates, strict income requirements, and risks tied to property performance.

Before moving forward, carefully weigh the pros and cons, consider your long-term investment goals, and explore all available options. For some, alternatives like a home equity loan, HELOC, or home equity investment might offer better terms or lower risk.

Ready to finance your real estate investment dreams? Tap into equity with no monthly payments, no income requirements, and no need for perfect credit. Learn more at Point.com. 

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