Getting approved for a mortgage can be a time-consuming process — not to mention rather intrusive. One homebuyer interviewed by Business Insider described the process as a “borderline invasion of privacy,” while real estate correspondent James Rodriguez called it a “financial colonoscopy.”
That’s why Rodriguez wrote that “wannabe real estate moguls” bet big on a once-obscure type of loan during the pandemic when the market was booming. While it helped some build “mini-empires,” others now stand to lose those investments.
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During the early days of the pandemic, “become a landlord” content on TikTok went viral amid surging home prices and bidding wars. Thousands of small-time investors rushed into the real-estate market using debt service coverage ratio (DSCR) loans, a little-known instrument that doesn’t require personal income verification, like a conventional mortgage does.
But now, as rents stagnate and operating costs rise, yet interest rates remain high, some of these small-time investors are struggling to pay their bills. And that’s putting thousands of small landlords at risk of foreclosure (1).
How DSCR loans work
While conventional mortgage approvals can be time-consuming and intrusive, most lenders limit how much debt you can take on relative to your income. Freddie Mac and Fannie Mae limit the number of conventional mortgages you can take out for rental properties — and their requirements become more stringent as you finance more properties (2).
A debt service coverage ratio (DSCR) loan allows the borrower to avoid the hassles of applying for a conventional mortgage and borrow beyond what might be permitted by lenders looking at their personal finances alone. Unlike a conventional mortgage, a DSCR loan is based on whether the expected income generated by the rental property will be enough to cover the loan payments.
The DSCR is calculated by dividing the annual net operating income (NOI) of the property by the amount needed to pay the principal and interest on the debt each year — known as the debt service. NOI is used to forecast the cash flow from a property. It’s calculated by adding up all the revenue that comes in from a property, such as rent, parking and laundry, and then subtracting all operating expenses such as maintenance, property taxes and insurance.
For example, if the NOI on your property is $150,000 and your debt is $100,000, then your DSCR is 1.5. In general, lenders prefer a higher DSCR (which means borrowers are less likely to default on their loans) — and typically require that it be at least 1.2 (3).
While DSCR loans have been around for decades, they surged in popularity during the early days of the pandemic, when the average rate on a 30-year mortgage was historically low — at times below 3% (4) — and housing prices (5) and rents were rising (6).
At the same time, “landlord influencers took to social media to preach the gospel of BRRRR — an acronym for Buy, Rehab, Rent, Refinance, Repeat — which they hailed as the golden path to financial freedom,” Rodriguez wrote. And some turned to DSCR loans.
SFR Analytics data shows that DSCR lenders handed out more than $44 billion in loans in 2022, according to Business Insider’s reporting (1).
In 2022, when interest rates started to skyrocket, rent growth slowed dramatically. This made it harder for landlords to generate income while their debt service payments rose. Since that time, DSCR loan delinquencies nearly doubled from about 2% in early 2023 to almost 4% by the end of 2024, according to S&R Global Ratings data (7).
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Other options for prospective investors
DSCR loans are a legitimate financial product, but some investors have used them as part of an unsustainable plan to get rich quickly.
“People got hooked on the cheap money,” Alex Offutt, a DSCR executive and industry veteran, told Business Insider. “Anybody can be successful when the money’s cheap” (1).
When financing products offer easy approvals with little scrutiny into your personal finances, it’s cause for caution. In the early pandemic years, for example, “wannabe real estate moguls” were increasingly pushing the limits of loans in the hope that rents would continue to rise rapidly while lenders were loosening their standards.
Prospective investors should fully understand how DSCR loans work — and how relying on future rental income could backfire. They should also stress-test rental properties using conservative assumptions and understand how insurance, maintenance costs and vacancy risks could impact their future revenue streams.
A conventional mortgage offers better terms and rates, but it may not be a fit if you’re purchasing multiple properties. Another option is a commercial real estate loan, though these loans have stricter qualification requirements (8).
This impacts renters, too. If a highly leveraged investor falls behind with loan repayments, buildings could be sold to institutional buyers or enter foreclosure. Tenants could face rising fees, deteriorating conditions or even eviction, depending on state and local laws. If you’re a prospective tenant, research the ownership structure of the home you plan to rent and make sure you understand local and state tenant-protection laws.
Some industry insiders told Business Insider they see the market heading toward a healthier equilibrium, since prospective landlords will need to be surer of the prospects for success amid slow-growing rents and sustained higher borrowing rates.
Additionally, delinquent borrowers may be able to pay off their obligations by selling their properties. This could be a silver lining, as it would bring properties to the market that are well-suited to first-time homebuyers (1).
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Article Sources
We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.
Business Insider (1); Rocket Mortgage (2); AmeriTrust (3); Federal Reserve Bank of St. Louis (4); Federal Reserve Bank of St. Louis (5); iProperty Management (6); S & P Global (7); NerdWallet (8)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.