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What is the Debt Service Coverage Ratio (DSCR)?
The **Debt Service Coverage Ratio (DSCR)** is a financial metric that measures the ability of a property or business to produce enough cash flow to cover its debt obligations. It is a key indicator used by commercial lenders to determine the risk of a loan. The ratio compares the Net Operating Income (NOI) to the total annual debt service.
The DSCR Formula
How Lenders Interpret DSCR
A lender wants to see that you have a cash flow cushion. A DSCR of 1.0 means your income exactly covers your debt payments, leaving no room for error. Most lenders look for a higher ratio:
- DSCR < 1.0: Negative cash flow. You do not have enough income to cover debt payments. Loan will likely be denied.
- DSCR = 1.0: Breakeven cash flow. Income exactly matches debt payments. Very high risk for lenders.
- DSCR > 1.25: This is generally considered a good and healthy ratio by most lenders for commercial real estate. It shows you have a 25% cash flow cushion after paying your debts.
Frequently Asked Questions (FAQ)
What is included in "Total Debt Service"?
Total Annual Debt Service includes all principal and interest payments for all loans associated with the property or business over a one-year period. For a property, this would be the sum of all 12 monthly mortgage payments.
How can I improve my DSCR?
There are two ways to improve your DSCR: 1) **Increase your Net Operating Income (NOI)** by either raising rents/prices or decreasing operating expenses. 2) **Decrease your Total Debt Service** by refinancing your loan to a lower interest rate or a longer term, which reduces your monthly payments.