Traditional mortgages are a sore spot not just for career real estate investors, but for every aspiring investor who earns their income in a “non-traditional way” — that is, W2 employment. Independent contractors, self-employed workers, entrepreneurs, gig economy workers, and investors of all stripes often have trouble getting approved for an investment mortgage, even if their non-traditional income streams are more than sufficient to pay that mortgage.
DSCR loans open doors for such investors when traditional lenders close. This is because many DSCR lenders don’t look at the borrower’s personal tax returns, pay stubs, or proof of W2 income. It’s not the same thing as the “no-doc mortgage” of times past, but for investors who have been rejected despite robust income, these different documentation requirements can be a breath of fresh air.
Munoz Ghezlan Capital helps investors and aspiring investors get approved for a DSCR loan without tax returns, paystubs, or W-2 income. In this article, we will clarify how it all works.
Key Takeaways
- Self-employed individuals, independent contractors, and entrepreneurs tend to have erratic income and declare little taxable income, making them a bad fit for inflexible “qualifying mortgages” (QM) that must conform to Fannie/Freddie guidelines.
- DSCR loans are investment mortgages based on the income potential for the property, not personal employment income. Many DSCR lenders do not require paystubs, W-2s, or personal tax returns at all.
DSCR loans are not subprime loans or “no-doc mortgages.” The borrower must still pass a credit check and provide traditional documentation — but not proof of W-2 income.
Why DSCR Loans Attract Non-Traditional Earners
The reason non-traditional earners struggle to qualify for a traditional mortgage is that these mortgages (also known as “qualifying mortgages” or “QM loans”) must adhere to the guidelines set forth by federal mortgage associations like FMAE (“Fannie Mae”) and FHMC (“Freddie Mac”).
These guidelines are based on the “American Dream” of a lifelong W2 career and a family home with a white picket fence. As such, the primary borrower qualification is their employment income, verified by paystubs, personal tax returns, and W2 employment agreements.
Yes, QM mortgages exist for real estate investments, but the Fannie/Freddie guidelines curiously don’t stray far from the primary-residence qualifications. It doesn’t matter how much rental income the property has the potential to generate — in fact, QM lenders don’t even consider it. All they care about is your paystubs and tax returns.
Why This is a Problem for Non-Traditional Earners
Non-traditional earners like independent contractors, business owners, entrepreneurs, gig-economy workers, and investors often have more sporadic income. They don’t receive the same amount of money every month from an employer like clockwork. There are no “paystubs,” and a few months’ lookback of their personal income may not tell the story of their earning potential. It’s not uncommon for non-traditional earners to have to hand over 12 months or more worth of bank statements and contracts to satisfy a skittish lender.
Tax returns can be an even bigger problem. Business owners, independent contractors, and other entrepreneurs tend to qualify for many tax deductions, legally allowed to write nearly off nearly every business expense. This is especially true of real estate investors, who qualify for many lucrative tax deductions. The result — a very small amount of declared income on the tax returns, and the conundrum of a six- or seven-figure earner being told by QM lenders that they “don’t make enough money” to qualify.
QM lenders also tend to refuse to write mortgages in the names of LLCs or other limited liability companies. Their mandate is to lend to people, not companies.
Finally, QM lenders will only extend one borrower so many loans — after taking a certain number of them, QM lenders will cut a borrower off. This is a big sticking point for investors who want to build a big portfolio, sending them on the hunt for alternative loans like DSCR loans and portfolio loans.
What Is a DSCR Loan?
A DSCR loan is a kind of real estate investment mortgage where the income of the property does matter. In fact, it’s the main thing that matters. A DSCR lender, in fact, may not ask for your tax returns and W2s at all.
This doesn’t make it a “no-doc loan” mind you. Different documentation is required. However, the documentation is all based around whether or not the property can generate enough income to cover the mortgage payment.
A DSCR loan is a non-QM loan that doesn’t conform to Fannie/Freddie guidelines. As such, DSCR loans tend to have somewhat higher interest rates, down payments, and loan origination fees. However, they can be an important source of real estate investment financing for non-traditional earners who can’t qualify for traditional loans with their old-fashioned approach to income qualification.
Why Tax Returns and W-2s Are Not Required
An investor can get a DSCR loan without tax returns or W-2s because the lender isn’t interested in income unrelated to the property — only the income potential of the property itself.
As the name would suggest, the main factor is the DSCR of the property, or the “debt service coverage ratio.” This is a measurement of the property’s ability to produce enough rental income to cover the mortgage based on two factors:
- Net Operating Income (NOI): All income the property can generate in a year (rent, fees, amenities, etc.) minus all operating expenses. Note that the mortgage payment is not considered an operating expense for the purposes of NOI calculation.
- Annual Debt Service: One full year’s worth of payments on the DSCR mortgage the borrower is applying for.
You can learn more about how DSCR is calculated in this article. Note that the borrower’s personal employment income plays no role in calculating DSCR.
DSCR for Self-Employed Borrowers: Why It’s a Perfect Fit
Since most DSCR lenders don’t ask for W2s, paystubs, or personal tax returns, this makes them a perfect fit for self-employed borrowers and other entrepreneurs. The fact that they don’t receive paystubs doesn’t matter, nor does it matter that they reduce their tax burden by taking many deductions and declaring minimal income.
Note that some DSCR lenders do ask for paystubs and tax returns. It’s not the only thing they look at, but they do look at it. Munoz Ghezlan Capital keeps files on which DSCR lenders as for W-2 income reports and tax returns, and which don’t.
DSCR lenders will also lend to LLCs or other limited-liability entities — in fact, they prefer it. This helps self-employed individuals and investors preserve the chain of title and structure their investment correctly while limiting their liability.
DSCR Loan Requirements (What Replaces Tax Returns)
Borrower Requirements
- Credit Score Minimum — borrowers usually must have a personal credit score of 660-680 at minimum, with higher scores unlocking better terms. Some DSCR lenders will go as low as 600 or below in their credit score qualification, but the terms are often less favorable.
- Entity — most DSCR lenders prefer to lend to an LLC, corporation, or other limited-liability entity which the borrower must have established and ready to go, even if it’s a newer entity.
- Experience — some DSCR lenders want to see a track record of real estate investment success on the part of the borrower, but other lenders are open to first-time investors. Munoz Ghezlan Capital also keeps track of lenders that accept newcomers to the space.
Property Requirements
- Eligible Properties — single-family homes, condo units, townhomes, 2-4 unit multifamily properties, some larger multifamily properties. Certain DSCR lenders will accept mixed-use, rural, or non-traditional properties, but they are usually disallowed. Hotels, motels, mobile homes, and commercial or industrial property are usually not eligible.
- Condition and Marketability — property must be safe, habitable, and clear potential to generate income.
- Debt Service Coverage Ratio (DSCR) — DSCR of at least 1, sometimes higher. (DSCR calculation explained in more detail here.)
Financial Requirements
- Down Payment Requirements — usually 20-30%, with an LTV of 70-80%.
- Reserve Requirements — borrower must have cash reserves equal to 3-6 months’ mortgage payments depending on the lender, sometimes as many as 12 months’ worth.
- Seasoning Requirements — down payment funds must be “seasoned” (that is, sitting in a business bank account) for at least one month, sometimes 3-6 months. Any large deposits must be accounted for.
- Source of Funds Disclosure — borrower must document and disclose where all down payment funds have come from. Some DSCR lenders will accept borrowed funds as down payment, others don’t. Munoz Ghezlan Capital keeps track of which do and which don’t.
No-Doc Mortgage vs DSCR Loan: What’s the Difference?
A DSCR loan is not a “no-doc mortgage” as used to exist. No-doc loans were part of the high-risk “subprime” mortgage boom that led to the 2008 Global Financial Crisis and the Great Recession. Since these crises, no-doc loans have largely disappeared.
DSCR loans may not be QM mortgages, but they are not subprime mortgages. They do look at the borrower’s credit score and carefully underwrite every deal, albeit with different requirements. They are a kind of conventional mortgage, well-established within the real estate debt market.
Who Should—and Should Not—Use a DSCR Loan Without Tax Returns
Best Candidates
- Self-employed investors, including independent contractors, gig-economy workers, business-owners, and entrepreneurs.
- Landlords with expanding portfolios reaching the end of their access to QM loans.
- BRRRR investors who need speed and flexible refinancing rules.
Poor Fits
- Owner-occupants — DSCR loans are for investment properties only.
- Deals with thin margins that can’t absorb the higher cost-of-borrowing of DSCR loans.
- Speculative investments that depend more on appreciation than rental cash flow.
Bottom Line
For investors tired of being asked for their W2s and tax returns, and being declined when their income and employment history doesn’t fit into a neat box, DSCR loans are a viable alternative. Although they come with higher down payments and a higher cost of borrowing, they focus on the income potential of the property, not the borrower’s employment status. Many don’t even request W-2s, pay stubs, or personal tax returns.
If you’re looking for a DSCR loan without tax returns or paystubs, schedule a free strategy call with a Munoz Ghezlan DSCR loan expert today. We keep detailed records of which DSCR lenders will never ask for your W-2, paystubs, or personal tax returns, no matter how big your portfolio grows.
