DSCR
Debt service coverage ratio is net operating income divided by annual debt service. It asks one question: does the property produce enough to pay its own loan?
NOI $30,000 ÷ debt service $24,000 = DSCR 1.25.
The property generates 25 percent more than the loan requires.
Reading the number#
Below 1.0 — the property does not cover its debt. The shortfall comes from the owner's pocket every month.
1.0 — exactly break-even, with no margin for a vacancy, a repair or a tax increase.
1.25 — the common lending benchmark, and roughly the point at which an ordinary bad year is survivable.
1.50 and above — comfortable, and usually reflecting either low leverage or a strongly performing asset.
Why lenders like it#
A DSCR loan underwrites the property rather than the borrower.
Conventional investment property lending examines the borrower's personal income, debt-to-income ratio and tax returns. For a self-employed investor with substantial deductions, or one who already holds several properties, that analysis produces a decline regardless of how well the properties perform.
DSCR lending asks whether the building covers the payment. That is a narrower question and, for an income property, a more relevant one.
The trade is price. DSCR loans generally carry higher rates and larger down payments than conventional financing, and frequently prepayment penalties.
Sizing a loan from it#
Work backwards.
Maximum annual debt service = NOI ÷ required DSCR.
NOI of $30,000 at a required 1.25 gives $24,000 a year, or $2,000 a month. From that payment, the rate and the amortisation term determine the loan amount.
That is the calculation that decides how much a property can borrow, and it is independent of what the buyer earns.
Where it goes wrong#
In the NOI, as always.
A DSCR of 1.25 computed on an NOI that omitted vacancy, reserves and management is not 1.25. Recalculate it on a defensible NOI and the same property may cover its debt only barely — which is the situation that produces investors funding shortfalls from savings and calling it a temporary problem.
Our DSCR calculator runs both directions: coverage from a given loan, and maximum loan from a required coverage.
Read it with cash-on-cash#
The two answer different questions and they check each other.
Cash-on-cash asks what the deal returns.
DSCR asks whether it survives.
A high return with thin coverage is a fragile deal. Coverage without return is a safe one that does not pay. Neither number alone tells you which you are looking at.