Debt Service Coverage Ratio (DSCR): What Lenders Really Look At
Understand how lenders evaluate whether a property generates sufficient income to cover debt payments.
The Debt Service Coverage Ratio (DSCR) measures a property's ability to cover its debt obligations from its operating income. It's a critical metric for lenders and investors.
Formula: DSCR = Net Operating Income (NOI) / Annual Debt Service
Example: - Annual NOI: $50,000 - Annual Debt Service (mortgage payments): $40,000 - DSCR: $50,000 / $40,000 = 1.25
Interpreting DSCR: - DSCR > 1.0: Property generates more income than needed for debt payments - DSCR = 1.0: Income exactly covers debt (breaking even) - DSCR < 1.0: Income insufficient to cover debt (negative cash flow)
Lender requirements: - Most lenders require minimum DSCR of 1.20-1.25 - Higher ratios may qualify for better loan terms - Commercial properties often need higher DSCR (1.30-1.40) - Lower DSCR increases default risk
Why investors should care: - Indicates cash flow cushion - Shows investment risk level - Affects loan qualification and terms - Helps assess property's financial health
A healthy DSCR provides a buffer for unexpected expenses, vacancies, or economic downturns. Always aim for DSCR above lender minimums to ensure sustainable cash flow.