Debt Service Coverage Ratio (DSCR) is an important metric for commercial lenders and banks to assess the ability of a property to service the loan. It is intended to measure whether a debt can be paid back with incoming cash flows. If you have insufficient cash flows as a borrower, you’ll not be capable of generating a satisfactory ROI (return on investment).
The debt service coverage ratio is a lender’s primary tool for measuring your ability to repay loans and stay current on payments. It is a measure of your income versus your expenses. Actually, it’s a measure of the amount of rental income collected against the amount of debt service. With the DSCR calculator, you can easily evaluate the debt service coverage ratio.
But before starting to use this tool, we recommend that you first read through this article to find out more about the debt service coverage ratio and learn how to calculate it yourself. Below you can also find how the results are interpreted and what the minimum acceptable DSCR is. Once you have all the facts at your fingertips, you will be able to make investment decisions with ease.
What Is DSCR?
We have already revealed some facts about the debt service coverage ratio. In this section, we’ll dig a bit deeper and provide a more thorough explanation of DSCR for better understanding. What does it stand for?
Debt service coverage ratio (DSCR) is a measure of the ability of a company to meet its interest and principal payments. It is defined as the ratio of cash flow from operations to total debt service. DSCR is a financial ratio that measures the proportion of earnings before interest and taxes (EBIT) that is available to cover fixed charges. It is calculated by dividing EBIT by total fixed charges.
A high DSCR indicates that the company has sufficient cash flow from operations to cover its debt obligations and thus is less likely to default on its loans. A low DSCR indicates that the company may have difficulty meeting its debt obligations and may be more likely to default on its loans.
Several factors affect the debt service coverage ratio of an asset, each of which should be taken into account when calculating DSCR. One of them is the interest coverage ratio (ICR). In brief, it’s a measure of the ability of a company to meet its interest payments on loans. It is defined as the ratio of earnings before interest and taxes (EBIT) to total interest charges for any given period, typically one year.
DSCR Formula: How to Calculate It?
Now that you are acquainted with everything you could ever want to know about the debt service coverage ratio, you probably want to know how it’s calculated, right? While the DSCR can be calculated in a few different ways, our calculator is designed using the following formula:
DSCR = NOI / r * debt / [1 – (1 + r)^(-T)]
- Debt in this formula is actually the total amount of loan;
- r stands for the loan interest rate;
- T tells us how long it takes (expressed in years) to pay off the loan.
This formula is derived from the following equation:
DSCR = Net Operating Income (NOI) / Total Debt Service
Where:
- NOI stands for is the monthly net operating income; it’s calculated as follows: NOI = Revenue − Certain operating expenses (COE)
- Total Debt Service represents the current debt obligations of the company; it refers to the payments that are made every month toward paying off debt.
Example:
- Interest Rate: 4.00%
- Term (in years): 10
- Total Loan: $100,000
- Net Operating Income (NOI): $10,000
In this example, the DSCR is 98.19%. Put these figures in our calculator and check it out!
How to Interpret DSCR?
The debt service coverage ratio can be interpreted as a measure of the company’s ability to pay its debts. The higher the ratio, the more likely it is that the company will be able to pay its debts and interest on time.
DSCR is a metric used to measure a company’s ability to meet its debt obligations. This ratio is also sometimes known as the “coverage ratio.” It provides an indication of how much cash flow a company has available to cover its debt payments.
Once you’ve calculated DSCR, you should know how to interpret the result. For example, a DSCR of 1.5 means that for every dollar in interest expense, there are $1.50 in earnings before tax and interest expense. A DSCR of 2 means that for every dollar in interest expense, there are $2 in earnings before tax and interest expense (EBITDA).
If a property has a debt service coverage ratio of 1.5 or 2.0, then it is considered to be fully paying for its debt. A debt service coverage ratio of 3.0 would be considered “high quality” and this is the ratio for many of the best lenders. The higher the number the more likely the debt service from the property will pay the mortgage.
What Is a Good DSCR?
The debt service coverage ratio is often calculated for the current property and comparable property. A ratio of 1.15 or higher is considered good for residential property, but many lenders require ratios at a minimum of 1.20. However, keep in mind that property managers and investors may operate with higher ratios sometimes.
- DSCR ≥ 1: This means operating income generated by a company is sufficient to cover interest payments and annual debt.
- DSCR ≥ 2: It is considered an ideal debt service coverage ratio. Such a high ratio indicates that the company can take on more debt.
What Is the Minimum Acceptable DSCR?
Many lenders use this measure when deciding whether or not to provide loans to companies. Most of them are not willing to give a loan if the DSCR is lower than 1.20. So it’s considered to be the minimum acceptable DSCR. So, what can you expect?
If your DSCR is below this value, the majority of potential borrowers are going to reject your loan application. However, if you are considerably above this value, i.e. if your DSCR is substantial or pretty high, your chances of getting a loan will be very good. What’s more, you may get it more quickly than you would expect!