Smart real estate investors know that it’s not a question of “if” they will get a mortgage loan to buy property. Leveraged equity is a risk-managed strategy to get exponential upside. The leverage available through mortgage loans enables them to buy more property with the same nest egg and scale their portfolio many times faster.

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So it’s not a question of “Will I get a loan?” but “Which loan will I get?” For house-flippers, BRRRR investors, Airbnb investors, and buy-and-hold investors in homes, condos, and duplexes, the key decision in front of them is DSCR loan vs. conventional loan. Understanding the difference is critical to select the right option.

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Munoz Ghezlan Capital has helped hundreds of real estate investors not only identify the right category of loan to choose, but identify the right lender and cross the finish line to approval and funding so they can start — or grow — their empire. Here’s a “starter guide” to help you answer the question “DSCR loan vs. conventional loan – which is better for my real estate investment?”

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Key Takeaways

• “Conventional” (or “conforming”) loans conform to the guidelines of Fannie Mae and Freddie Mac, making them easy to sell on the secondary market. As such, they are lower-risk to the lender and come with better terms and lower cost-of-borrowing. Approval depends on your personal income, employment history, and debt-to-income ratio.

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• DSCR loans do not depend on the borrower's income and employment, but on the income potential of the deal. They are higher-risk to the lender and carry higher down payments and cost of borrowing. Approval depends on the debt service coverage ratio (DSCR), a measurement of the property’s income potential compared to the annual debt service. 

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• A conventional loan may be the right choice for an investor who is steadily employed, has sufficient time to close, plans to use the property as a primary residence, and/or is just starting out as an investor.

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• A DSCR loan may be the right choice for career real estate investors and entrepreneurs who have inconsistent income, take many tax deductions, have to close quickly, have many loans on other properties, or want to execute a BRRRR or Airbnb strategy.

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What Is a “Conventional Loan,” Exactly?

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What makes a mortgage loan “conventional"?” We throw the phrase around all the time, but what do we mean by it?

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When we talk about a “conventional” loan, it usually means a “conforming” loan — is a loan that meets guidelines set by the two major US government-sponsored mortgage organizations: 

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• The Federal National Mortgage Agency (FNMA, commonly known as “Fannie Mae”) 
• The Federal Home Loan Mortgage Corporation (FHLMC, or “Freddie Mac”). 

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These organizations have a mandate from the Federal government to maintain the affordability, stability, and liquidity of the US housing and real estate market.

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Are Conventional Mortgages Insured by Fannie Mae and Freddie Mac?

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Contrary to what many people think, Fannie Mae and Freddie Mac do not “insure” home mortgages. 

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The US departments of Veterans Affairs, Agriculture, and the Fair Housing Administration do  insure loans, which is why lenders can offer such good rates on VA, USDA, and FHA loans (the insurance reduces their risk).

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What conforming to Fannie/Freddie guidelines does do is turn home mortgages into a commodity that can easily be sold on the secondary market. Companies and funds buy large portfolios of conventional loans from the lenders who write them, confident in the risk profile of Fannie/Freddie underwriting without having to double-check every line of every mortgage. 

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Mortgage lenders can thus quickly and easily liquidate their loan portfolio by selling it on the secondary market, turning loans into cash to use for operations, expansion, and issuing new loans. This means it is also lower-risk for lenders to write conforming loans — not as low-risk as a mortgage insured by the US government, but low-risk in the sense that lenders can be confident they will have a buyer for the mortgage waiting in the wings.

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Lenders who issue conventional loans are sometimes called “QM” lenders. The “QM” stands for “qualifying mortgage.”

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What Is a DSCR Loan?

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A DSCR loan is a type of “non-QM” mortgage — meaning they don’t conform to the standards of Fannie Mae and Freddie Mac. 

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They’re not “unconventional” in the traditional sense — they’re a very well-established product in the lending market, not some shady mob loan. All it means to be non-QM is that they have much more flexibility in how they underwrite loans. 

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However, it also means every loan is different, making them harder to sell on the secondary market. Because of this increased risk, non-QM loans usually have less favorable terms for the borrower than an equivalent QM loan.

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How DSCR Loans are Different from Other Non-QM Loans

DSCR loans are not the only non-QM loans on the market, so what makes them different? 

A key component of Fannie/Freddie guidelines is that the underwriting hinges heavily on the borrower’s personal income, employment history, and personal debt load. 

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A DSCR loan, on the other hand, focuses the underwriting on the income potential of the property itself — current rent, market rent, fees, etc. The borrower’s personal employment and income history is usually ot factored in. 

This makes it an attractive loan category for real estate investors who derive the majority of their income from real estate deals or who would prefer the property to matter more than their personal income.

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DSCR loans get their name from the “debt service coverage ratio,” a key metric in determining whether property income will be sufficient to cover the mortgage payment.

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DSCR Loan vs. Conventional Loan – Key Differences

Underwriting Criteria

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• Conventional Loan: Based on the borrower’s personal income, employment history, and debt-to-income ratio.

• DSCR Loan: Based on the income potential of the property, particularly the debt service coverage ratio (which factors in income, expenses, and the amount of debt being requested).

Speed of Approval

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• Conventional Loan: 30-45+ days

• DSCR Loan: 5-15 days

Documentation Requirements

• Conventional Loan: ID, personal tax returns, W-2s, pay stubs, bank statements, verification of employment, appraisal.

• DSCR Loan: Property income statements (if available), ID, bank statements for cash reserve requirements, business plan, appraisal.

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Flexibility of Property Types

• Conventional Loan: Primary/secondary homes, some investment properties.

• DSCR Loan: Investment properties ranging from 1-4 units, sometimes as high as 8 units or more. Higher unit numbers usually require a commercial mortgage.

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LTV/Down Payment Differences

• Conventional Loan: 5-20% down payment depending on the property use. Owner-occupied property (even 2-4 units with the other units rented out) usually qualify for lower down payments. 80-95% LTV.

• DSCR Loan: 20-30% down payment, 70-80% LTV.

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How The Different Lenders Calculate Income

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Every lender wants to confirm that their borrowers have enough income to make their payments. However, conventional lenders and DSCR lenders calculate income very differently. Here’s how income calculation applies to DSCR loan requirements vs. conventional loan requirements.

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Conventional Lenders

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To comply with the guidelines of Fannie Mae and Freddie Mac, conventional lenders must prioritize the borrower’s personal income and employment history. This is most easily verified with:

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• The past 30 days’ worth of pay stubs.

• W-2 forms dating back 1-2 years.

• 1-2 years’ worth of personal tax returns, especially for self-employed persons, business owners, or borrowers with inconsistent or unpredictable income.

• Written Verification of Employment (WVOE), especially for borrowers with new jobs and variables like overtime, commissions, and bonuses.

• Offer letters, for jobs that the borrower has not started yet.

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Conventional lenders can also rely on third-party employment databases for further verification. 

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Within 10 calendar days, the lender will usually call the HR department to verify everything reported to them about the borrower’s employment history to make sure it matches and the borrower has not recently lost or quit the job. This is called direct verification of employment (DVOE).  

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For borrowers who have maintained steady, consistent employment, this is relatively easy. However, it often becomes a thorn in the side of self-employed persons, gig workers, and business owners. 

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It can be especially problematic for entrepreneurs who deduct many business expenses from their taxes. This reduces their tax burden, but also puts a very small number at the bottom of their tax return, making it look like they earn little or no income. 

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Because real estate investors qualify for many generous tax deductions, this makes it especially hard (paradoxically) for them to meet the income requirements of a conventional loan.

Debt To Income Ratio (DTI)

One of the most important ingredients in conventional mortgage calculation is the debt-to-income ratio (DTI). This is calculated as follows:

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DTI = Total Monthly Debt Payments ÷ Gross Monthly Income

Note that the mortgage you’re applying for does count towards the lender’s debt calculation. Expenses like utilities, health insurance, and internet/wireless bills do not. Other debts they can find by pulling your credit and corroborating the payments with bank statements.

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DSCR Lenders

DSCR lenders do not rely on the personal employment income of the borrower; in fact, they usually don’t even ask for it. No W-2s, no paystubs, no employment verification. Instead, they look at the income potential of the property. 

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This could take the form of:

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• Form 1007 on the Appraisal, the appraiser’s professional opinion of the property’s market rent and income potential.

• Existing rent and leases in place if the property is already being used as a rental property, usually represented by the lease agreements and trailing 12-month income/expense statements. 

• Data sources like AirDNA if the borrower intends to reposition the property as an AirBNB.

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For real estate investors who take many tax deductions and report very little personal income to the IRS, this can be a breath of fresh air — a lender who will actually look at the potential of the property itself, rather than ignoring the property and putting their employment history and tax returns under a microscope.

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Debt Service Coverage Ratio (DSCR)

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As the name suggests, the debt service coverage ratio (DSCR) is of primary importance when DSCR lenders look at the borrower’s income potential from the property. DSCR is a number that expresses, at a glance, the potential of the property to make the mortgage payments on the loan the borrower is requesting.

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Here’s how it works, in brief:

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DSCR = Net Operating Income (NOI) ÷ Annual Debt Service

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The net operating income (NOI) represents the property’s income minus operating expenses for the year. The annual debt service represents twelve months’ worth of mortgage payments.

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If this equation produces a DSCR of exactly 1, that means the property has exactly enough NOI to cover the debt service, albeit with nothing left over for investor cash flow. 

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If the DSCR comes out greater than 1, there is enough NOI to cover the debt service with a surplus. For example, a DSCR of 1.15 means the property produces enough income to cover the debt service, with an extra 15% on top as the owner’s cash flow.

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If the DSCR comes out less than 1, there isn’t enough NOI to cover the debt service. If the DSCR is 0.95, for example, there is a 5% shortfall that the investor must make up somehow in order to cover the mortgage.

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Learn more about how DSCR is calculated here.

DSCR Loan Requirements vs. Conventional Loan Qualification

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We know a little more now about what’s required to get a DSCR loan vs. a conventional loan. Let’s get a little more specific about what is required to qualify for each loan. 

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Conventional Loan

• Credit Score: 620 or higher. Best rates kick in at credit scores over 700.

• Debt-To-Income Ratio (DTI): Conventional lenders usually require a debt-to-income ratio between 43% and 50% or lower.

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DSCR Loan

• Credit Score: 620 or higher. Best rates kick in at credit scores over 700.

• Debt Service Coverage Ratio (DSCR): DSCR of at least 1. Some lenders require 1.1, 1.2, or even more. Under special circumstances, even a DSCR below one may be approved.

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Pros & Cons of Conventional Loans

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Pros

• Lower down payments.

• Lower interest rates.

• Lower closing costs.

Cons

• Requires approval based on personal income and employment history.

• Longer approval times. 

• Limit on the number of loans you can have at one time. 

• Will not fund into an LLC. 

• Longer “seasoning” requirements for refinance — usually 6-12 months. 

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Pros & Cons of DSCR Loans

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Pros

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• Approval is based on the income potential of the property itself, without regard to personal income, employment history, or number of tax deductions.

• Fast approval. 

• Can have as many loans as you want as long as you keep bringing the lender attractive deals.

• Will fund into an LLC.

• Shorter “seasoning” requirements for refinance — usually 1-3 months.

Cons

• Higher down payments (20-30% instead of 5-20%).

• Higher interest rates (usually +1-2%).

• Higher closing costs (usually +1-3%).
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Is a DSCR Loan Better Than A Conventional Mortgage? Ideal Use Cases for Each 

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So which option is better for the real estate investment you have in mind? Here are different use cases where one mortgage might be better than the other.

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When a Conventional Loan is Better

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• The Investor Has Consistent, Verifiable Employment History and Income and Low Debt. If the investor has had a consistent, high-paying job and little debt, it may be easy to check all the boxes for a conforming loan. This will give them access to the favorable terms (lower interest, down payment, closing costs) available to conforming loans that pose less risk to the lender due to their value on the secondary market.

• The Investor Has Time to Close. If the investor does not need to close the deal in a hurry, it might be worth it for the better terms to wait the 30-45 days or longer it takes to get approved for a conventional loan.

• The Investor is Just Starting Out. If the investor is a beginner with no track record of success in real estate investing, DSCR lenders might be more reluctant to take the chance, potentially offering less favorable terms. A conventional loan may very well be the better choice for aspiring new investors.

• The Investor Plans to Live In The Property. Owner-occupied properties are considered much more low-risk to the lender. The expectation is that the borrower will make extra effort to avoid losing their own home. As such, down payments tend to be much lower. This applies even if the borrower is a “house-hacker” buying a duplex, triplex, or fourplex with the intent on living in one unit and renting out the others.

When a DSCR is Better

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• The Investor is Self-Employed, a Business Owner, or Full-Time Real Estate Investor. Entrepreneurs, especially career real estate investors, tend to take many deductions on their taxes, reducing their tax bill at the expense of looking like paupers on their tax returns. Other entrepreneurs have inconsistent or variable income, making it harder for them to fit into the box of Fannie/Freddie conformity. For these borrowers, a DSCR loan may be the go-to product to finance their deals.

• The Investor is Pressed For Time. An investor may need to close quickly. The property could have been bought at a foreclosure auction, or the seller may be in distress and within days of foreclosure. The potential for fast approval on a DSCR loan could be the secret sauce that saves the deal.

• The Investor Has Many Other Loans on Other Investment Properties. Conventional lenders will only give you so many loans before refusing to lend any more. By contrast, DSCR lenders will write as many loans as you bring them appealing deals, even if you have many other mortgages on many properties.

• The Investor Wants to Execute the BRRRR Strategy. The BRRRR strategy (buy-rehab-rent-refinance-repeat) is particularly well-suited to DSCR loans because of the third “R” — refinance. A conventional loan must usually be “seasoned” for 6-12 months before the lender will consider refinancing the loan. With the 1-3 month seasoning requirement of a DSCR loan, the investor can refinance and use the proceeds to move on to the next deal much more quickly, allowing the investor to scale faster. 

• The Investor Wants to Use the Property as an Airbnb or Short-Term Rental. Conventional mortgage underwriting — even for investment properties — has no mechanism for evaluating the income potential of a short-term rental or Airbnb. DSCR lenders, on the other hand, lend to Airbnb projects all the time. Their underwriting is much more flexible, and they avail themselves of a variety of data sources to take your Airbnb plan seriously. 

Bottom Line

Both conventional (conforming) loans and DSCR loans have their strengths and weaknesses, as well as circumstances where one is the better choice than the other.

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Conventional loans depend on the borrower’s personal income and employment history, and you can only take out so many of them at a time. But if the borrower is new to real estate investment, has stable income and employment history, and/or plans to live on the property, they offer low down payments and lower cost-of-borrowing.

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DSCR loans, on the other hand, depend on the income potential of the property, can fund into an LLC, and can fund quickly. Is a DSCR loan better than a conventional mortgage? Not always. The cost-of-borrowing and down payments are higher, but for entrepreneurs with variable income and many tax deductions, BRRRR or Airbnb investors, or when time is of the essence, DSCR loans have the edge.

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‍Munoz Ghezlan Capital can help you choose between DSCR loans vs. conventional loans, connect you with the lender best suited for your project, and advocate for speedy closing. That’s how we help investors profit, scale, and prosper. If you want to be our next success story, schedule a free strategy call with us today to discuss whether a conventional or DSCR loan is right for you.

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