Applying for a home loan is a pain. You have to produce a heap of documents — bank statements, tax returns, employment records, tallies of investment accounts — to prove the stability of your financial footing, then wait for a mortgage underwriter to comb through all of it before giving you the thumbs up. I spoke with one exasperated homebuyer who described the process as a “borderline invasion of privacy.”
While the average American submits to a financial colonoscopy en route to their dream home, wannabe real estate moguls have found a way to sidestep the hassle. With the help of a once-obscure type of loan, they’ve built mini-empires ranging from a few homes to a few hundred — without the usual scrutiny from lenders. These landlords include small-time investors eager to expand their portfolios, TikTok tycoons seeking new streams of real estate revenue, and seasoned property managers looking to make smart bets. In recent years, they’ve taken out billions of dollars’ worth of “debt-service coverage ratio” loans — often abbreviated as DSCR — to hoover up homes. The loans enable income-seeking owners to quickly purchase rental properties while dodging annoying questions about their job history or outstanding debts. DSCRs may sound complicated, but obtaining one is relatively straightforward: A landlord just has to show their lender that the desired property will generate enough rent to cover the monthly payments and other basic expenses, such as taxes and insurance. The lender focuses on the property’s cash flow, not the borrower’s personal creditworthiness.
For some of these landlords, the cash isn’t flowing as planned. Serious delinquencies on DSCR loans have nearly quadrupled in the past three years, data from the real estate analytics firm Cotality shows. Although the troubled loans account for only a small fraction of the total dollar amount of outstanding DSCR loans, they’re a sign that debt-laden landlords face shakier economics amid a rental market slowdown. And while people in the industry defend the idea behind the loans — “It’s still a great product,” one lending veteran tells me — they acknowledge the spread of some sketchy practices that contributed to the spike in bad debt, including ambitious rent targets, hasty approvals, and loans for properties where the rental income wouldn’t even cover the basic monthly payments.
Despite all the hand-wringing over Wall Street-backed giants gobbling up homes, it’s the small and midsize players — prime candidates for DSCR loans — that make up the lion’s share of investor purchases. If lenders tighten their standards in response to the recent turbulence, that could mean fewer budding land barons angling for houses. Regular buyers might benefit from less competition for available homes or the forced sales of some of these places. But a little shakiness in the short term doesn’t mean these loans, along with the investors seeking real estate riches, will disappear. Big asset managers, keen on putting their money to work in real estate, have embraced the product. And with more people turning to rentals instead of buying, more landlords will take on this debt to multiply their holdings — even if some of their dreams of building real estate kingdoms come crumbling down.
Most people are content to snag their small slice of the American dream, buying one or maybe a couple of properties that they can call home. But there’s also a growing class of entrepreneurs chasing real-estate riches. Say you decide to become one of those landlords: You own a couple of rental homes that pull in good money, but you’re itching to buy more. Odds are you’ll need a loan — it’s expensive, and probably unwise, to tie up all your cash in a property when you could use it to do all kinds of other things, like pay for repairs or maybe even purchase more places. The Blackstones and Pretiums of the world have ample access to debt, but it’s trickier for a little guy like yourself. Even if your finances are golden, Freddie Mac and Fannie Mae limit the number of so-called “conventional loans” you can get to buy up houses and turn them into rentals. Alternatively, you may encounter a limit with your debt-to-income ratio — you can only take on so many liabilities before the typical lenders put the brakes on any further borrowing. This is when you may turn to the world of DSCR loans, where a bevy of lenders promise quick closings, little inspection of your personal finances, and practically unlimited access to more money down the line, as long as you can find rental properties that promise to deliver cash.
True to their name, debt-service coverage ratio loans center on one key metric: the ratio of the property’s expected rental income to its mortgage payment and basic monthly expenses, such as taxes, insurance, and association fees. Let’s say the home you’ve set your sights on brings in $3000 in rent each month, while those expenses total $2,500. Divide that first number by the second, and you get a coverage ratio of 1.2 — well within the typical range for a DSCR loan. Lenders prefer the ratio to be above 1, so that the soon-to-be owner has a little cushion to cover unexpected expenses that are likely to arise, such as a broken water heater or repairs on an aging HVAC system.
DSCR loans for residential investors have been around for more than a decade, but they really came into vogue during the pandemic, when borrowing rates dropped and investors saw a chance to capitalize on rising home prices and juicy rent hikes. 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. Some of these evangelists leaned on DSCR loans to buy or refinance their properties, extracting equity from their homes and using the funds to scoop up more rentals. Larger firms also began purchasing loans from smaller private lenders, packaging them into portfolios worth hundreds of millions of dollars, and selling the resulting income streams as bonds, a process known as securitization. The embrace by so-called “institutional investors,” such as insurance companies and asset managers, who purchase these bonds, along with growing demand from small- to midsize landlords, enabled the industry to flourish. Data from SFR Analytics, a real estate analytics firm specializing in single-family rental homes, shows that DSCR lenders churned out more than $44 billion in loans in 2022, up from just $5.6 billion in 2019.
“It really went from an unknown asset class, or very small asset class, overlooked by much of the commercial world,” says Hunter Latta, an executive at the DSCR lender Renovo Capital.
“Fast forward to today, it’s a full-blown, widely accepted asset class.”
However, several things happened in 2022 that made it trickier for investors to wring cash out of their properties. The Federal Reserve began jacking up interest rates to fight inflation, making it more expensive to borrow money. Home prices had surged in the Covid era, so the properties landlords had invested in during the pandemic came with larger loan balances and heftier monthly payments. With Americans feeling financial pressure and fewer forming new households, the pace of rent growth also slowed. By March 2023, according to Cotality, single-family rents were up just 4.3% year over year, down from the 13.3% jump recorded a year prior. Some landlords found themselves in a bind: They’d taken on loans with higher rates, expecting rents to keep pace. But investing in real estate was no longer the slam dunk it had been just a year or two earlier.
The percentage of DSCR loans in “serious delinquency” — meaning that payments are at least 90 days late or the property is in foreclosure proceedings — has nearly quadrupled since mid-2022, Cotality data shows. Just under 2% of securitized DSCR loans (those packaged together and sold as bonds) fell into that bucket as of August, compared with around 0.5% at the same point in 2022. That may not sound like much, but quadrupling the amount of troubled debt has been enough for lenders to take notice. By contrast, only about 1% of conventional loans are seriously delinquent, according to data from the Mortgage Bankers Association.
Roby Robertson, an executive vice president at LoanLogics, a mortgage technology company, likens this period to a “hangover in a really hot market.” The most challenged loans these days were originated in 2022 and 2023, right when the market was turning. Landlords who might have aimed for a conventional loan couldn’t make the math work, so they turned to a DSCR to make their investment dreams come true. Some lenders offered quick closings and “sub-unity loans,” which meant that the debt coverage ratio on the home was less than 1 — the rent wouldn’t be enough to cover the loan payments right out of the gate, so the landlord was either betting on the home’s value increasing substantially in the future, or that rents would climb enough to cover the costs. On the other side of the deal, the lender might figure that the landlord had enough skin in the game to make it work: DSCR borrowers usually have to put down at least 20% of the home’s value, and often significantly more, in order to get approval, which makes them unlikely to walk away from a property even if they’re losing money on it.
Other landlords chose to refinance a traditional loan into a DSCR one, a double-edged sword: Though the new loans allowed them to capitalize on higher home prices and pull money out for more deals, they also wound up locked into higher borrowing rates, requiring higher rents to make the payments.
“There is a direct correlation between cash-out refinances and delinquency,” says Alex Offutt, a DSCR executive and industry veteran, referring to landlords who took out loans right as borrowing rates jumped. “You’re taking out the cash to go buy more properties, but rents aren’t keeping pace with property values, right? So you had people that essentially got themselves into an over-leveraged position where they were not able to collect the rent they thought they could.”
Some of these loans left other real estate lenders scratching their heads.
“We’ll have a loan that we look at and say there’s no way we’d finance that, no way we’d get to that leverage amount,” says Sean Kelly-Rand, a managing partner at RD Advisors, an investment firm in Boston. “And then all of a sudden we’ll see them get a DSCR loan, and we’re like, what?”
Despite the uptick in delinquencies, DSCR loans continue to boom. Landlords secured more than $38 billion in DSCR loans tied to over 100,000 properties last year, according to SFR Analytics. Through October of this year, lenders have cranked out another $32.8 billion on almost 89,000 rental homes. The country’s two largest mortgage lenders, United Wholesale Mortgage and Rocket Mortgage, both now offer DSCR loans, with Rocket announcing its entrance to the space just last month.
Comparing recent delinquency rates to 2022 can be misleading, says Robertson, the LoanLogics executive. Low interest rates and rising home prices at the time made it relatively easy for almost anyone to make money in real estate. Additionally, delinquencies are now trending in the right direction, having decreased slightly from a peak of 2.2% early this year. With this perspective in mind, Robertson refers to the rise in bad debt as “natural growing pains of an industry that’s kind of hot right now.”
“With the market growing as fast as it’s growing, I think it’s actually pretty healthy,” Robertson tells me.
Owners of single-family rental homes face a mixed bag, though. The rent-versus-buy math tilts firmly in their favor — an analysis by the research firm Zelman concluded that the calculation leans toward renting to a degree that hasn’t been seen since the early 1980s. If people continue to choose renting over buying, that’ll be a boon for landlords. On the other hand, rent growth is middling. Single-family rents in August were up just 1.4% year over year, according to Cotality — a 15-year low. And while some of these landlords may be sweating over stagnant or even falling rents, investors who fall behind on their DSCR loans aren’t totally stuck: Because home prices have generally climbed over the past few years, delinquent borrowers are usually able to sell the house and pay off the loan, says Sujoy Saha, an analyst at S&P Global. Still, if fewer well-funded investors are chasing properties and more cash-strapped mini-moguls are dumping their distressed assets, that could mean better odds for regular first-time buyers, who often seek the kinds of entry-level properties that are typically turned into rentals.
For wannabe BRRRRers or members of the FIRE movement, skyrocketing home prices and rock-bottom borrowing rates made the rental business seem like the best way to make a buck just a few years ago. Landlords still see plenty of opportunities to come out ahead — but ultra-cheap loans are no longer part of the equation.
“People got hooked on the cheap money,” Offutt tells me. “Anybody can be successful when the money’s cheap.”
James Rodriguez is a correspondent on Business Insider’s Discourse team.
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