• Debt Service Coverage Ratio

    Debt Service Coverage Ratio Defined

    Debt service coverage ratio, sometimes called debt coverage ratio, is an underwriting criteria often misunderstood by even experienced investors. It is the amount of cash available for debt servicing divided by the annual debt payments. Lenders considering a commercial loan will certainly want to see the property generating at least enough income to make the mortgage payments. In fact, as a general rule, the lender will want to see available income greater than payments by a factor which is often around 25%.

    How is it Calculated?

    Here is the formula for calculating debt service coverage ratio:

    DSCR=Net Operating Income/Debt Service

    The income and debt figure are based on annual numbers. Doing a sample calculation should help us to understand this important ratio better. Let’s use some theoretical numbers for a loan on an apartment building. We will start by calculating the net operating income:


    Gross Potential Rents                        $850,000

    Less 5% Vacancy & Credit Loss          $42,500

    Effective Gross Income                      $807,500


    Maintenance & Repairs                           $5000

    Real Estate Taxes                                   $14,000

    Insurance                                                    $4000

    Janitorial                                                     $3500

    Management                                           $45,000

    Replacement Reserves                          $13,000

    Total Operating Expenses                    $88,500


    Net Operating Income                    $719,000 (Mortgage Interest not included)


    The following will be used to calculate debt service:

    Commercial Loan Size           $7,500,000

    Interest Rate                                    6.5%

    Term                                               30 years

    Annual Payments                 $568,869

    Having determined the Net Operating Income and the annual Debt Service we can use our formula for DSCR shown above to do the calculation:

    DSCR= $719,000 (NOI)/ $568,860(Debt Service)=1.26

    Analyzing Debt Service Coverage Ratio

    If the DSCR is less than 1.0 then then there is not enough income to make the mortgage payment and the investor would have to make up the difference from some other source.  This might or might not be acceptable to a bank considering the loan.  In fact, in most cases it will not be acceptable.   It would depend on the remainder of the investors financial picture.  In general, a lender will want to see the DSCR at around 1.25.  This would mean that the income from the property would pay the mortgage with about 25% left over. This extra 25% represents a “cushion” that would allow the borrower to continue making the mortgage payments if the income from the property decreased somewhat.  This cushion gives the lender some comfort that he will always get his monthly payment.




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