"DSCR Loans: Short-Term vs Long-Term Rental Strategies"

For real estate investors, securing the right financing is a cornerstone of building a successful portfolio. Among the array of options available, the DSCR loan, short for Debt Service Coverage Ratio loan, has emerged as a transformative tool. These loans represent a type of non-qualified mortgage (Non-QM), meaning they don’t strictly adhere to traditional lending criteria. Their unique feature is that they primarily rely on the cash flow generated by the investment property itself for qualification, rather than focusing on the borrower’s personal income, tax returns, or employment history. This makes them particularly appealing to investors, especially those who are self-employed or have complex financial situations.

The fundamental concept behind a DSCR loan is the Debt Service Coverage Ratio (DSCR). This ratio is calculated by dividing the property’s income (specifically, income available to service debt) by its total debt service obligations, typically the monthly Principal, Interest, Taxes, Insurance, and any Homeowners Association (HOA) fees – collectively known as PITIA. For DSCR loans specifically, the calculation often involves dividing the property’s income by the PITIA. A DSCR greater than 1.0 indicates that the property’s income exceeds the debt payment, signifying positive cash flow. While lenders generally look for a ratio of 1.0 or higher to indicate that the property’s income can cover 100% of the debt, minimum requirements can vary, with some seeking 1.2 or higher and others even accepting ratios below 1.0 in certain scenarios. A higher DSCR is typically viewed more favorably by lenders. Want to calculate yours? Try my DSCR Loan Calculator to see if your property makes the cut!

While the core principle of focusing on property cash flow remains constant, the application of DSCR loans differs when financing properties intended for long-term versus short-term rentals, primarily in how the income is assessed.

DSCR Loans for Long-Term Rentals (LTRs)

DSCR loans have a history of being used for financing traditional residential rental properties with long-term leases. When financing an LTR, lenders typically assess the property’s income based on the in-place rent if there is an existing tenant. If the property is vacant or the rental rate needs to be determined, lenders rely on a market rent appraisal, often documented using a 1007 Market Rental Income Survey report. Many lenders will use the lower of the in-place rent or the appraised market rent when calculating the DSCR.

This reliance on existing leases or established market rates provides a relatively stable and verifiable income figure, which can make the underwriting process straightforward for LTRs based on the DSCR calculation. This predictability makes DSCR loans a reliable option for investors seeking traditional rental income streams.

DSCR Loans for Short-Term Rentals (STRs)

With the growth of platforms like Airbnb and VRBO, short-term rentals have become a popular investment strategy, and DSCR loans are increasingly being used to finance these properties. DSCR loans are well-suited for STRs because they focus on property income, which is ideal for investors who might not qualify for traditional loans based on personal income for a potentially high-income STR property.

Financing STRs with DSCR loans presents a different income verification challenge compared to LTRs due to the fluctuating nature of nightly or weekly rental income. Lenders often consider projected income for STRs, especially if the property doesn’t have a long operating history as a short-term rental. Data services like AirDNA or VRBO data are commonly used to provide these income projections. Some sources mention that lenders may require historical booking data (typically 12 months) via the booking platform or property manager if available. Finding lenders who are specifically “short-term rental friendly” and willing to utilize these projections or historical STR income data is crucial for investors targeting this market.

Traditional appraisal methods, like the 1007 form which is typically based on long-term rental rates, often do not accurately reflect the potential income of an STR. This can make it difficult to meet DSCR thresholds if the lender only uses the long-term market rent for qualification. However, some DSCR lenders can use the 1007 survey with consideration for STR income, though this challenges conventional appraisal practices. Some lenders who are comfortable with STRs are also willing to lend in vacation or tertiary markets often designated as “rural” on appraisals, whereas lenders less familiar with STRs might reduce leverage, increase rates, or deny loans in such markets.

Lenders also recognize that STRs typically have higher operating expenses (cleaning fees, utilities, marketing, etc.) than LTRs. To account for this, some lenders may apply an expense factor (though not all do, and experienced investors might avoid it) to the gross rental income before calculating the DSCR. If you’re curious about your STR’s cash flow after expenses, my Cash Flow Calculator can help you crunch the numbers.

Key Differences in Application

The core distinction lies in the method of income assessment:

• For LTRs, income is usually verified using existing leases or appraised long-term market rent, which offers stability and predictability.
• For STRs, qualification often relies on projected income based on market data (like AirDNA) or historical booking data, requiring lenders specifically comfortable with these methods. Lenders may also apply expense factors to STR income.

Additionally, while a standard down payment for a DSCR loan is typically 20-25%, financing vacation or short-term rentals might require a higher minimum down payment, often 25%, with some lenders requiring 20-30%. The need for cash reserves (liquid assets to cover PITIA payments during vacancies or income interruptions) is particularly important for STRs to manage potential income fluctuations. Lender requirements for reserves typically range from 3 to 12 months of PITIA. Want to know how much you’re borrowing compared to the property’s value? Use my LTV Calculator to check your loan-to-value ratio!

Shared DSCR Loan Requirements and Considerations

Regardless of whether you’re financing an LTR or an STR, several aspects of DSCR loans remain consistent:

• Property Eligibility: DSCR loans can finance various residential investment property types, including single-family homes, 1-4 unit properties, multi-unit properties (up to 10 units with some lenders), and potentially even some commercial or mixed-use properties. The property must be used for business/investment purposes and cannot be owner-occupied.
• No Personal Income Verification: A defining characteristic is the absence of requirements for W-2s, tax returns, or verification of personal income or debt-to-income ratio (DTI).
• Credit Score: A minimum credit score is necessary, often starting around 660, although some may accept lower scores like 620. Higher credit scores generally lead to better terms. Creditworthiness is still considered, and poor credit or defaults can affect eligibility. DSCR loans typically do not report to personal credit bureaus.
• LTV & Down Payment: Lenders typically finance up to 75-80% LTV, meaning a 20-25% down payment is standard. Financing the down payment with seller financing or other liens on the subject property is generally not permitted.
• Documentation: While considered less burdensome than conventional loans (“not ‘no-doc’ loans”), documentation is required, focusing on the property and business entity (if applicable). This includes applications, credit authorization, bank statements for reserves, leases (for LTRs) or STR history (if available), property insurance (including flood if in a flood zone), and entity documents for LLCs. Lenders will also obtain documents like credit/background reports, appraisal reports (including the 1007 form), appraisal reviews, and title insurance.
• No Property Limit: A significant advantage for portfolio growth is that DSCR loans often have no limit on the number of properties an investor can finance.
• Entity Borrowing: Investors can typically qualify for a DSCR loan in the name of an LLC or corporation. This can help separate personal and business finances and keep the loan off personal credit reports. Lenders may require majority owners to act as guarantors. Entity documents are required.
• Loan Options: Common DSCR loan terms include 30-year fixed-rate mortgages, and interest-only options are also popular for the initial years (e.g., first 10 years) to boost cash flow.
• Faster Closing: Due to simpler documentation, DSCR loans can often close faster than conventional loans.
• Potential Drawbacks: Compared to conventional loans, DSCR loans typically come with higher interest rates and fees. Prepayment penalties are also common if the loan is paid off early. The loan’s viability is directly tied to the property’s cash flow; insufficient income or high vacancy rates can pose a risk of default. Cash-out refinances are available based on equity.

Looking to grow your portfolio beyond rentals? I’ve been exploring foreclosures with a course called Build a Fortune With Real Estate Foreclosures and Short Sales—it’s packed with strategies to snag deals below market value. Check it out here.

Finding the Right Lending Partner

Given the differences in underwriting, especially for STRs, selecting the right DSCR lender is crucial. Investors should seek lenders who understand their specific investment strategy, whether it’s LTRs, STRs, or even newer hybrid models like medium-term rentals. Lenders with expertise in STRs might be willing to use data from platforms like AirDNA, lend in vacation markets, and offer flexible terms.

If you’re curious about creative financing options for your rentals, the MicroBanking Method course has been a game-changer for me. It’s full of smart ideas for investors—take a look here

Conclusion

In conclusion, DSCR loans provide a flexible financing pathway for real estate investors by prioritizing a property’s income-generating capability over the borrower’s personal financial profile. While this core principle applies to both long-term and short-term rentals, the practical application differs significantly, primarily in how the projected or actual rental income is assessed and verified by lenders. By understanding these nuances, particularly the need for specialized lenders for STRs and the different methods of income evaluation, investors can effectively leverage DSCR loans to finance and expand their rental property portfolios, optimizing their approach based on whether they pursue stable long-term leases or dynamic short-term stays.

Ready to get started with a DSCR loan? My free DSCR Loan Checklist has all the steps you need to make it happen. Want to learn more about estimating rents for STRs? The Massive Real Estate Video Library has been super helpful for me—check it out here:  Got questions? Let’s chat on X (@DscRforrentals)!

Just so you know: This post contains affiliate links; I may earn a commission at no cost to you.