DSCR (Debt Service Coverage Ratio)

DSCR tells lenders whether a business or investment property generates enough income to cover its debt payments. It's the #1 metric for commercial real estate and business loans.

Formula: DSCR = Net Operating Income ÷ Annual Debt Service

Where:

• Net Operating Income (NOI) = Revenue
• Operating Expenses (before debt payments)
• Annual Debt Service = Total annual loan payments (principal + interest)

Example 1: Rental Property Property Details:

• Rental income: $36,000/year ($3,000/month)
• Operating expenses: $12,000/year (taxes, insurance, maintenance, HOA)
• Net Operating Income: $36,000 - $12,000 = $24,000
• Mortgage payment: $1,500/month = $18,000/year

DSCR = $24,000 ÷ $18,000 = 1.33

What DSCR Means:

DSCR < 1.0: ❌ Negative cash flow

• Not enough income to cover debt ❌ Example: 0.85 DSCR = only covering 85% of debt payments ❌ Lenders typically won't approve

DSCR = 1.0: ⚠️ Break-even

• Exactly covering debt payments ⚠️ No cushion for vacancies or repairs ⚠️ Risky, rarely approved

DSCR = 1.0-1.25: ⚠️ Tight cash flow

• Minimal cushion ⚠️ May be approved for strong borrowers ⚠️ Vulnerable to market changes

DSCR = 1.25-1.50: ✅ Good

• Industry standard for approval ✅ 25-50% cushion above debt payments ✅ Comfortable margin for expenses

DSCR > 1.50: ✅ Excellent

• Strong cash flow ✅ Easy approval, better rates ✅ Significant cushion for vacancies/repairs

Lender Requirements by Loan Type:

Example 2: Small Business Business:

• Annual revenue: $500,000
• Operating expenses: $380,000
• Net Operating Income: $120,000
• Loan payment: $7,500/month = $90,000/year

DSCR = $120,000 ÷ $90,000 = 1.33

This business generates 33% more cash than needed to cover debt—healthy DSCR for approval.

DSCR Rental Property Loans: New loan type (popular 2020+) for real estate investors:

• No income verification for borrower
• Approval based solely on property's DSCR
• Typical minimum: 1.0-1.25 DSCR
• Higher rates than traditional mortgages (7-10% vs 6-7%)

Why DSCR Matters:

For Lenders:

• Measures ability to repay debt
• Assesses default risk
• Determines loan approval and terms

For Borrowers:

• Shows if investment is profitable
• Determines maximum loan amount
• Indicates financial health

How to Improve DSCR:

Increase Income: ✅ Raise rents (rental property) ✅ Increase sales (business) ✅ Add revenue streams ✅ Reduce vacancy rates

Decrease Expenses: ✅ Negotiate better insurance rates ✅ Improve energy efficiency ✅ Refinance to lower rate ✅ Extend loan term (lower monthly payment)

Adjust Loan Terms: ✅ Larger down payment → smaller loan → lower payment ✅ Longer loan term → lower monthly payment ✅ Lower interest rate → lower payment

Example: Improving DSCR Current:

• NOI: $30,000
• Debt service: $25,000
• DSCR: 1.20 (borderline)

Strategy 1: Increase down payment

• Reduce loan by $50,000 → saves $3,000/year in payments
• New debt service: $22,000
• New DSCR: 1.36 ✅

Strategy 2: Increase rent

• Raise rent $150/month = $1,800/year
• New NOI: $31,800
• New DSCR: 1.27 ✅

Common Mistakes:

❌ Using gross income instead of NOI → Overstates DSCR ❌ Forgetting property taxes/insurance → Inflates NOI ❌ Not accounting for vacancies → Unsustainable DSCR ❌ Ignoring maintenance reserves → Overstates cash flow

DSCR vs Other Ratios:

DSCR: Income ÷ Debt payments (commercial/investment lending) DTI (Debt-to-Income): Debt payments ÷ Gross income (consumer lending) LTV (Loan-to-Value): Loan amount ÷ Property value (all lending)

The Bottom Line: DSCR is the gatekeeper for commercial and investment property loans. Aim for 1.25+ to get approved with good terms. Below 1.0 means you're losing money every month—not a sustainable investment.