Debt Service Coverage Ratio (DSCR)
Definition:
The Debt Service Coverage Ratio (DSCR) is a financial metric used by lenders to determine a property's ability to generate enough income to cover its debt obligations. It’s calculated by dividing the net operating income (NOI) by the total debt service (principal and interest payments). A DSCR greater than 1 indicates that the property produces enough income to cover its debt, while a DSCR below 1 means the property is not generating sufficient income to cover the debt payments.
🔍 Did You Know?
Most lenders require a minimum DSCR of 1.2 to 1.5 for real estate investments to ensure the property generates a comfortable margin above its debt obligations.
Examples:
Example 1:
An investor purchases a rental property with a net operating income of $60,000 and annual debt service of $50,000. The DSCR is calculated as:
[ $60,000 ÷ $50,000 = 1.2 ]
This means the property generates 1.2 times the income needed to cover the debt, which would likely meet lender requirements.
Example 2:
A commercial property has a net operating income of $100,000 and annual debt service of $120,000. The DSCR is:
[ $100,000 ÷ $120,000 = 0.83 ]
With a DSCR below 1, the property does not generate enough income to cover the debt, which would likely lead to loan rejection or require additional financial backing.
Why It’s Important:
The DSCR is crucial for lenders and real estate investors because it reflects a property’s ability to generate enough income to meet its debt obligations. A higher DSCR means lower risk for the lender, making it easier for the borrower to secure financing. For investors, a strong DSCR ensures the property is financially stable, with room for unexpected expenses or fluctuations in income.
Who Should Care:
- Real estate investors who need to demonstrate a strong DSCR to secure loans for income-generating properties.
- Lenders who use DSCR to assess the risk of lending on a specific property.
- Commercial property owners looking to refinance or expand their portfolios.
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