Thinking of investing in a rental property but do not where you’ll the get the money from? Investing in rental properties can be a fantastic way to build wealth and gain financial freedom. But before you jump into this exciting adventure, it’s important to have the right tools in your belt.

DSCR Loan and Convectional loan can help you with it. Let’s decode which one is better for you and your dream property!

1. What is a Conventional Loan?

These loans, typically offered by private lenders, banks, credit unions, and other institutions, come with adjustable or fixed interest rates. Unlike government-insured loans, they are not overlooked by the authorities. Factually, these loans follow a traditional mortgage structure with terms ranging from 15 to 20 years. A higher down payment is subject to interest in conventional Loans, as subjected to government-insured loans or DSCR loans.

 Although the down payment rates are subjective and may vary through lenders and institutions, a common requirement rate is 20% of the investment price. 

source: 1,2,3

1.1 Advantages of Conventional Loans:

• Wide-spread availability:  Conventional loans are readily available from many lenders. This makes them a great choice for all sorts of real estate investments, whether you’re looking for a cosy single-family home or a bustling commercial building.

• Competitive Interest Rates: Conventional loans can offer interest rates that are tough to beat, especially if you have a good credit score. This translates to potentially saving a big chunk of money on your investment, which can be a real game-changer.

• Flexibility in Property Type: conventional loans give you more freedom. You can use them to finance anything from a starter home to an apartment building, depending on your needs and goals.

• Potential for PMI Rates: Imagine you pay extra each month for mortgage insurance (PMI) because your down payment was less than 20% of the home’s value. This can mean a lower monthly payment, putting more money back in your pocket.

source: 1,2

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1.2 Disadvantages of Conventional Rates:

• Stringent Qualification Criteria: While conventional loans offer many benefits, qualifying for them can be difficult. They typically require a good credit score and a healthy debt-to-income ratio. This means if your income fluctuates or your credit score isn’t awe-inspiring, you may have a tougher time getting approved.

• Income Verification Required: Conventional loans often require detailed proof of income, which can be delicate for self-employed folks or those with income from poor traditional sources.

• Limited By Loan Limits:   conventional loans have limits on how much you can borrow, set by Fannie Mae and Freddie Mac. This can be a hurdle in expensive areas where property prices might soar above those limits.

source: 1,2

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2. What is the Debt Servicing Coverage Ratio:

Unlike Conventional Loans, DSCR Loans are primarily used for investment properties. Lenders focus on the property’s rental income to qualify you for the loan, not your income. This qualifying ratio compares the property’s rental income to its debt obligations, which is itself quite challenging for a buyer to tackle. Down payment requirements can vary, but they might be higher than conventional loans      (<  20%), as the properties are much in demand due to the recent boom.

source: 1,2

2.1 Advantages of DSCR Loans:

• Income-Centric: Unlike conventional loans that check your credit score, DSCR loans care more about the property’s ability to generate income through rent. Rental Income and Debt obligations are good to go, to analyse the property’s value under satisfying the owner’s pockets.

• Commercial Property Financing: DSCR loans often come with more flexible terms compared to conventional loans. This means you can potentially customize the financing to better fit your situation.

• Income Verification Flexibility:  DSCR loans don’t get hung up on traditional ways of verifying your income. This makes them affordable to those who have poorly incurred income sources.

• Focus on Property Cash Flow: DSCR loans care more about the property’s ability to pay for itself than your bank statements. So, if you have a property with a solid rental income history, qualifying for a DSCR loan might be easier than a conventional one.

• Quick Closing: DSCR loans often get approved faster than conventional loans. This is because they focus on the property’s potential rather than digging deep into your personal financial history.

source: 1,2

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2.2 Worries to get aware of: Cons of DSCR:

• Higher Interest Rates: The interest rates are typically higher than conventional loans because lenders take on more risk by not looking at your finances.

• Larger Down Payment: Be prepared to put more money down upfront compared to a conventional loan. DSCR loans often require a down payment of 20% or more, depending on the lender and the property’s income potential.

• Potential Prepayment Penalties: Some DSCR loans have prepayment penalties. This means you might face a fee if you decide to pay off the loan early, like if you sell the property soon after buying it.

• Stringent Qualification: While DSCR loans offer some flexibility, lenders can still be picky. They’re more likely to give you a good deal if the property you’re eyeing has a history of bringing in steady income. So, while they might not check your finances as intensely, the property itself needs to be a strong earner.

• Interest Rate: DSCR loans are a bit riskier for lenders since they don’t consider your income. It’s important to factor in the total cost of the loan over time to see if the benefits outweigh the extra expense.

source: 1,2

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3. The Final Saga DSCR Loan vs Conventional Loan:

Whether it is a good restaurant, a good property, or your spouse. It’s tough to choose between Good and Better. Everyone isn’t aligned to choose something out of the masses. So let us look at the bigger picture for the very last time to help you to decide:

Index	DSCR Loan	Conventional Loan
Purpose	They are primarily used for investment properties. Lenders focus on the property’s rental income to qualify you for the loan, not your income.	They are used for investment properties, primary residencies, or second homes. With qualifications based on credit score or income.
Qualification	This ratio compares the property’s rental income to its debt obligations	This ratio compares the property’s credit score to its income (personal).
Down Payment	Down payment requirements can vary, but they might be higher than conventional loans.	Down payment requirements can vary depending on the loan type, but they typically range from 3% to 20%.
Interest Rates	DSCR loans are considered non-QM (non-conforming) loans, this translates into higher interest rates.	The interest rates for conventional rates are much lower than DSCR loan
Availability	DSCR loans are a niche product and might be less readily available compared to conventional loans.	Conventional loans are a common product and might be more readily available compared to DSCR loans.

3.1 Property type and Investment strategy:

• DSCR Loans: It’s high time for Income-generating properties like apartment buildings or storefronts. They care more about the rent the property brings in than what type of property it is.
• Conventional Loans: Offer more flexibility in terms of property type. You can use them for anything from a single-family home to a vacation rental.

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3.2 Risk Tolerance:

• DSCR Loans: These can be easier to qualify for if your credit score isn’t perfect. They focus on whether the property itself can make enough money to cover the loan.
• Conventional Loans: Typically require a good credit score. This might be a better option if you have a strong credit history and are comfortable with stricter requirements.

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3.3 Down payment capability:

• DSCR Loans: This might allow for a smaller down payment depending on the lender and the property’s income potential.
• Conventional Loans: often require a larger down payment upfront (around 20% or more).

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3.4 Long Term vs Short Term Goals:

• DSCR Loans: Ideal for long-term investments where you plan to hold onto the property for a while and generate steady rental income.
• Conventional Loans: Might be a better fit if you’re looking for more flexibility for short-term investments or building a diverse real estate portfolio.

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3.5 Interest Rate Sensitivity:

• DSCR Loans: Might have slightly higher interest rates, but if the property brings in a good amount of rent, the extra income might outweigh the higher interest cost.
• Conventional Loans: Typically offer lower interest rates.

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4. DSCR Loans vs Conventional Loans: Which is Better?

There’s no one-size-fits-all answer. Consider your property type, investment goals, risk tolerance, down payment situation, and how sensitive you are to interest rates. There is a lot to prefer and a lot to choose from, and ultimately the choice depends on the circumstances, vision, the state of the market, choices aligned with the property, and much more. At last both the loans are probably best to look out for.

source: 1,2,3

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5. FAQs:

5.1. How is the eligibility for a conventional loan is determined?

Eligibility for Conventional Loans is often determined by a borrower’s credit score, Debt-to-Income ratio (DTI), down payment amount, and overall financial stability.

5.2. 5 key differences between DSCR Loan vs Conventional Loans:

1. Loan Limit:

If conventional loan options are exhausted, DSCR loans provide a viable alternative for real estate investors seeking continued financing.

2. Credit Score:

Credit scores below 660 may limit conventional loan options in today’s market. Consider alternative financing solutions.

Keep in mind, that a lower credit score means a more expensive loan. A more expensive loan will lower your cash flow. Lower cash flow might disqualify you for the loan.

3. Holding a property DSCR vs Conventional::

Unlike conventional loans, DSCR loans often come with prepayment penalties if you pay them off too early (typically 3-5 years). This makes them ideal for long-term investors who plan to hold onto the property.

4. Property Condition:

 DSCR and conventional loans favour properties already generating income, making them a better fit for move-in-ready rentals or refinancing completed renovations.

5. Interest-only option:

DSCR loans stand out with interest-only payment options, boosting your cash flow for 5-10 years. This benefit is absent in conventional loans, which require principal repayment alongside interest.