Leveraging DSCR Loans for Airbnb and Other Short-Term Rentals

By Bill Lyons | Published on May 17, 2023

Short-term rental properties can help you build wealth over time, and thanks to the popularity of Airbnb, becoming a real estate investor is easier than ever before. A short-term rental with regular bookings can outperform long-term rental properties like apartments or single-family homes. Additionally, you can expect your home’s value to increase in value — or appreciate — over time.

Funding can be a major roadblock for would-be real estate investors. Securing a loan for a rental property can sometimes be challenging, but that doesn’t mean it’s impossible. With a DSCR loan, you can qualify for a loan for short-term rentals and Airbnb.

DSCR loans for short-term rentals are available for new and seasoned investors, allowing you to purchase rental properties with more flexible requirements than other types of loans for Airbnb. Interested in learning more about a DSCR loan for Airbnb and other short-term rentals? This article will discuss how these loans work, their benefits and limitations, and how you can qualify.

How DSCR Loans Work

Your personal income, credit score, and job history largely determine traditional mortgage loan eligibility. Unfortunately, strict lending criteria can prevent inventors from securing a loan for their next investment property. In addition, unlike traditional W2 employees, investors take deductions on their taxes, reducing their taxable income. While deductions have several benefits, such as tax savings, large deductions can affect their ability to meet eligibility requirements on conventional loans.

DSCR loan eligibility is determined by a borrower’s debt service coverage ratio (DSCR) instead of personal income or job history. Instead of reviewing pay stubs, W2s, and tax returns, lenders calculate DSCR to determine a borrower’s ability to repay the loan.

You can calculate DSCR by dividing your gross rental income by the debt service (including principal and interest). A DSCR of 1.0 indicates that you earn enough in rental income to afford to repay the loan. However, as you may already know, investors have other expenses, such as operating costs, marketing, payroll, etc. Therefore, lenders like to see a DSCR of at least 1.25 to ensure you can afford to repay the loan and cover costs that may otherwise compromise your ability to pay back your loan.

Ultimately, the higher your DSCR, the more money you have to repay your debts, which reduces some of the risks for lenders and borrowers.

DSCR loans are only available for rental properties; they can’t be used to purchase a primary residence or for flipping a house because they rely on cash flow generated from the investment property. The DSCR helps lenders quickly determine whether a borrower can repay the loan without the need for personal income verification, allowing faster closing times and a streamlined approval process.

Qualifying for a DSCR Loan

The most important factor in determining eligibility for a DSCR loan is your debt service coverage ratio. As we’ve mentioned, a DSCR of 1.0 indicates you have enough rental income to repay the loan, but a DSCR higher than 1.0 can make you more appealing to lenders. Borrowers with a lower DSCR may still qualify for a loan but may be required to use personal accounts to pay the rest of the mortgage premium.

If you have a low DSCR, lenders will find you less appealing. However, you can prove your ability to repay with your DSCR and other ways, such as income verification via bank statements or assets, to reduce some of the lender’s risk.

Some lenders may require you to maintain a minimum DSCR throughout the life of the loan, so it’s always a good idea to understand your DSCR loan terms to ensure you’re making the right choice.

As we’ve mentioned, lenders prefer to see a DSCR of at least 1.25, but requirements vary. For example, Griffin Funding allows DSCRs as low as 0.75, allowing more borrowers to qualify based on the cash flow of their rental properties.

In addition to DSCR, borrowers must meet a lender’s down payment and credit score requirements. Typically, lenders like to see good or better credit scores, and a higher credit score can help you get more favorable terms. Additionally, lenders can determine which types of rental properties qualify for DSCR loans. For example, some lenders may not allow you to use a DSCR loan for a mobile home.

DSCR Loans vs Traditional Loans for Rental Properties

Traditional loans for rental properties have stringent lending requirements because they’re sold to Fannie Mae and Freddie Mac, companies that operate the secondary mortgage market. Conventional loans are then sold through the market to investors worldwide. Since these loans are sold in the secondary mortgage market, they have specific underwriting requirements, such as income, assets, credit score, and collateral.

It’s much more difficult for investors to obtain traditional loans for rental properties because of the deductions they take on their tax returns or have losses on other investments. Additionally, Fannie Mae and Freddie Mac do not allow borrowers to purchase property as an LLC and have restrictions on how many investment properties an investor can own.

Conventional loans may be an attractive option because they typically come with lower interest rates if you qualify.

DSCR loans for Airbnb and other short-term rental properties allow borrowers to qualify based on the property’s market rent instead of business or personal income. Additionally, there are no limits on the number of properties you can buy with the loan, and you can purchase property in the name of an LLC, which has potential tax benefits.

Using DSCR Loans for Airbnb

DSCR loans for Airbnb can help you generate income faster because they offer faster closing times. You can use DSCR loans to finance Airbnb properties based on the rental rates for properties in the area or Airbnb rates if you have a long history as a host. Like any other type of investment property loan, DSCR loans for short-term rentals have their benefits and limitations.

Benefits

The most significant benefit of a DSCR loan for Airbnb and other short-term rentals is the ability to qualify without providing personal income documentation. DSCR loans don’t take into account personal financial information, making them easier for new investors to obtain financing. Other benefits of DSCR loans for short-term rentals include the following:

• Faster closing times: Because lenders only have to verify a property’s DSCR and borrowers don’t have to submit personal financial information, DSCRs typically have a faster application and closing process.
• No limit on the number of properties: DSCR loans allow you to invest in multiple properties simultaneously instead of having to pay off your loan before purchasing a new property.
• Unlimited cash-out: DSCR loans for Airbnb allow you to take out as much cash as you need based on your home’s equity. Cash-out can help cover costs such as maintenance and repairs to get your rental property back into shape between guests.
• Separates personal and business finances: If you close in the name of an LLC, you can keep your DSCR loan separate from your personal finances to ensure you pay the loan using business finances.

Limitations

No mortgage loan is perfect, so you should weigh the pros and cons of DSCR loans for Airbnb to determine if they’re right for you. Here are a few of the limitations of DSCR loans for short-term rentals:

• Large down payment: You can expect a large down payment with any investment property loans because they’re considered a higher risk for lenders. However, DSCR loans typically come with higher down payment requirements to mitigate some of the lender’s risk.
• Limited financing: DSCR rates are competitive, but these loans provide less overall financing with loan amounts up to $5,000,000. If you need more than that, you’ll have to shop around for another type of investment property loan.
• Potential cash reserves requirement: Short-term rentals like Airbnb rely on your ability to continuously get bookings. Lenders want to know you have a backup plan if you go for long stretches without guests, so they may require a certain number of months of cash reserves to ensure you can repay your loan.
• Potential for further debt: Vacancies mean your property isn’t generating cash flow, which can affect your ability to repay your loan. If your rental property goes for long periods without a guest, you’re still on the hook for paying off your mortgage loan. Unfortunately, you risk foreclosure without cash flow, which can affect your personal and business finances.

Managing Your DSCR Loans

DSCR loans can benefit new and seasoned real estate investors, offering them faster closing times and more flexible lending criteria. With a DSCR loan, you’ll qualify based on current or future cash flow from the property you purchase instead of relying on traditional income verification. However, it’s essential to understand all your loan options for Airbnb and other short-term rentals.

Griffin Funding allows DSCRs as low as 0.75, but not every investor will qualify for the loan. We can help you determine the best loan program for your next investment project to ensure you choose the right financing option. Ready to begin your next real estate project? Apply with Griffin Funding today.

Bill Lyons

Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 21 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up important with changes in the industry to deliver the most value to Griffin's clients.