Debt Service Coverage Ratio (DSCR) basics

The Debt Service Coverage Ratio (DSCR) is a financial metric used in mortgage lending to determine a borrower's ability to make payments on a loan. The ratio is calculated by dividing the property's net operating income (NOI) by the amount of annual debt service (ADS) payments required on the loan.

The DSCR is a measure of cash flow available to pay the loan payments. It tells the lender how much of the NOI is available to service the debt, after accounting for all operating expenses, such as property taxes, insurance, utilities, and maintenance costs. A higher DSCR indicates that the property generates enough cash flow to cover the loan payments comfortably, while a lower DSCR indicates that there may be a risk of default.

Different types of lenders have different requirements for DSCR, with commercial lenders generally requiring higher DSCRs than residential lenders. Generally, a DSCR of 1.0 or higher is considered acceptable, meaning that the NOI is sufficient to cover the loan payments. However, many lenders prefer to see a DSCR of 1.2 or higher to ensure that there is a cushion for unexpected expenses.

Lenders also use DSCR to compare different investment opportunities and determine which ones are more attractive. A higher DSCR means that a property generates more cash flow per dollar of debt, making it a better investment opportunity. Conversely, a lower DSCR means that the property generates less cash flow per dollar of debt, making it a riskier investment.