Debt-service coverage ratio (DSCR)

Before you rely on it

What to check

Ask which income figure the lender uses and what vacancy and management allowances they impose.

The common error

Where people go wrong with debt-service coverage ratio (DSCR)

Using the seller's income figure. Underwritten NOI is almost always lower, and coverage computed on the optimistic version can clear the threshold while the lender's version does not.

Worked through

Debt-service coverage ratio (DSCR) in plain numbers

A small apartment building earns $150,000 a year in net operating income. Its mortgage payments total $100,000 a year, principal and interest. DSCR is $150,000 ÷ $100,000, or 1.5. Every dollar of debt payment is covered with fifty cents to spare. Now suppose vacancies push income down 20%, to $120,000. The ratio drops to 1.2. Lower it another notch and the cushion vanishes: at 1.0 the income only just meets the payment; lenders set their own minimums, often somewhere around 1.2 to 1.35 for commercial property, and they may test the ratio under a stress case as well as at today's numbers.

Easily confused

Debt-service coverage ratio (DSCR) and its neighbours

DSCR is not the interest coverage ratio and not the debt-to-income ratio. Interest coverage divides earnings by interest only, and ignores principal repayment, so it flatters heavily amortizing debt. Debt-to-income compares monthly debt payments with a person's gross income, and it is used mostly for consumer loans. DSCR compares the cash a property or business generates with all its required debt payments, principal included. Definitions of income vary, since some lenders use net operating income and others use EBITDA, and ask which numerator and which debt payments a lender uses before comparing ratios.

In real decisions

Where debt-service coverage ratio (DSCR) turns up

Lenders use DSCR to size loans: the maximum loan is the amount whose payments keep the ratio above their minimum; investors use it to test whether a property can carry its debt. Business owners track it against loan covenants, since a breach can trigger penalties or higher rates. Credit analysts use it to rank borrowers. When you shop for a commercial loan, DSCR tells you how much room you have if income dips.

Know the edges

Where debt-service coverage ratio (DSCR) stops being reliable

The ratio reflects one year of income and one set of assumptions. A single large tenant leaving can change it overnight; it ignores capital needs such as roof replacements, and balloon payments do not show up in a normal calculation. Interest-only periods produce a flattering ratio that worsens when amortization begins. Test income at lower levels, use realistic vacancy and expense figures and check how the ratio looks after the interest-only period ends.

Quick answers

What people ask about debt-service coverage ratio (DSCR)

What DSCR do lenders want? It depends on the lender and property. Many commercial lenders ask for about 1.2 to 1.35 or more. Stronger ratios can bring better terms.

How do I improve DSCR? Raise net income through rents or lower expenses, or reduce debt service by extending the term or making a larger down payment. Each moves the ratio in a different way.