What is Debt Service Coverage Ratio (DSCR)

The comparison (ratio) of a Real Estate Property's cash flow compared to its debt obligation is known as a Debt Service Coverage Ratio (DSCR). It is a number used widely by lenders in commercial lending (Investment Property Loans) to analyze the ability of the borrower (or firm) to cover their debt obligation. 

DSCR loans are not dependent upon the borrowers personal Income. The Borrowers Income is not a component evaluated for the DSCR loans by lenders when underwriting a DSCR loan. These loans are dependent upon the properties ability to generate rent on their own. 

The Debt Service Coverage ratio is calculated by dividing the Total Annual Net Operating Revenues by the Annual Debt payments. Annual Operating Net Revenue takes into account the Income, Depreciation, Interest Expense, Amortization and any other non-cash items. Annual Debt Payment takes into account the cumulative Annual Principal, Interest and  Lease Payments. 

If the result (DSCR ratio) is a positive number( one or above), it means the individual or firm has the capacity to repay the loan. The higher the number, the better the chance of approval and favorable financing terms. Minimum DSCR ratio is based upon the lender's underwriting criteria and vary from one lender to another. 

A DSCR Loan is used to finance Investment Properties only. Important question is whether or not, the property can pay for itself. The formula to calculate the Debt Service Coverage ratio (DSCR) is Rental Income divided by Principal, Interest, Taxes, Insurance and Association dues (PITIA). 

The following five types of properties are eligible for DSCR loans:

(1) Single Family Residence or Townhome

(2) 2-4 Units

(3) Warrantable and non-warrantable condos - Warrantable are Fannie Freddie compliant loans and non-warrantable are the loans that do not comply with Fannie/Freddie guidelines

(4) Condotels - A condominium that is rented as a hotel, a set-up for short term rentals, where they could have a staff at check-in desk and a cleaning service. 

(5) Mixed use/Commercial 1-8 Units - a combination of residential and commercial set up, for example a unit that has commercial shops on ground floor and apartments on floors above. 

The minimum loan amount is 150,000.00 and the maximum amount is 3000000.00 (3 million) depending upon the investor. These amounts are driven by the credit score of the borrower, Investor Experience "how long and how extensive the borrower has experience in the activity" and the DSCR ratio. 

The Loan to Value (LTV) is calculated based upon the lender and typically includes:

(1) Purpose of the Loan

(2) Credit Score - typically required over 650. The higher the score, the better

(3) Type of Property

(4) Property location

(5) DSCR ratio

The Pre-Qualifying questions for a DSCR loan are as under:

(1) Is the borrower under a contract

(2) The estimated value of the property or the purchase price

(3) Estimated Purchase Date 

(4) Address of the Property or location

(5) What is the Borrower's credit score

(6) The Borrower's Investor Experience - how long and how extensive is the borrowers similar experience