Lenders pay close attention to your Debt Service Coverage Ratio, or DSCR. It compares the operating income you have available to service debt to your overall debt levels. Divide your net operating income by debt payments, on either a monthly, quarterly, or annual basis – or use this DSCR calculator – to find your Debt Service Coverage Ratio before determining what size loan to apply for.
Debt Service Coverage Ratio Calculator:
What is Debt Service Coverage Ratio?
When analyzing the size of a loan to take out for an investment property, the Debt Service Coverage Ratio (or DSCR ratio) can help you and your lender make a informed decisions. Debt Service Coverage Ratio helps quantify your ability to make your mortgage payments based on the rental income derived from the property. DSCR is represented as a ratio of how much more income your property produces compared to the size of your loan payments.
Debt Service Coverage Ratio Formula
The Debt Service Coverage Ratio formula is simply:
DSCR = Net Operating Income / Annual Debt Service
As you will know by now, Net Operating Income consists of a number of components that make up gross operating income and operating expenses. These include property taxes, insurance, utilities, property management fees, and more. Calculate this using this simple NOI Calculator.
What is Debt Service Coverage Ratio in Real Estate Used For?
To ensure a mortgage can be supported by the cash flow of a property, DSCR compares the annual Net Operating Income (NOI) to the annual mortgage debt payments. Lenders will look at this DSCR ratio before determining whether they will finance your real estate property and at what interest rate. Typically, lenders require a DSCR in the 1.25–1.5 range, depending on the project.
What Information Will I Need to Calculate the DSCR Ratio?
- Net Operating Income (NOI)
- Annual Debt Service
First, determine the Net Operating Income (gross rental income minus operating costs) of your property. Calculate this easily using an investment property calculator like our NOI Calculator. Then, find your Annual Debt Service, which is the principal and interest of your mortgage that you will pay over the course of one year.
How to Calculate DSCR?
To calculate DSCR, divide the NOI by the Annual Debt Service to calculate the Debt Service Coverage Ratio. Use our simple DSCR calculator above or follow the debt service coverage ratio formula:
Net Operating Income / Annual Debt Service = DSCR
Often your mortgage lender will analyze the Debt Service Coverage Ratio of an investment property that you plan to purchase before approving your loan. For this reason, this helps them verify that you’ll be able to make your mortgage payments. You can also use the DSCR calculator to determine the down payment amount that makes sense for your mortgage.
What is a Good Debt Service Coverage Ratio: An Example
A Debt Service Coverage Ratio greater than 1 means that the investor will earn enough income to cover their debt payments. Anything less than 1 means the borrower will need to find additional money to pay their regular loan payments. Typical A and B lenders require a DSCR in the 1.25–1.5 range. This means that your rental property produces 25-50% more of additional income after debt service. A DSCR of 1.5-1.75 is even more desirable, and could help lower your interest rate.
For example, investor Rudy identifies a rental property he wants to purchase. Using our NOI calculator, he figures his net operating income to be $50,000 per year. However, he will need to finance this property with a loan that requires a monthly $4,000 mortgage payment. His annual debt service comes to $48,000. Turning to his DSCR Calculator, he sees that his DSCR ratio is 1.04 ($50,000 / $48,000). While he would earn just enough rental income to cover his mortgage payments, there is not much else left. A lender would worry that a minor decline in cash flow would leave Rudy unable to pay his debt.
Rudy’s lender requires a minimum debt service coverage ratio of at least 1.5. Based on his $50,000 net operating income projection, this means Rudy can take out a loan with annual debt service of $33,333 ($50,000 / $33,333). This works out to approximately $2,778 per month .
DSCR Calculator: Takeaway
Debt service coverage ratio is one of the most important metrics used in real estate investing. When applying for a loan, it is important to know the minimum qualifications required by your bank or lender. This can help you adjust your offer to produce an optimal DSCR and ensure you are not setting yourself up for default.
Using the DSCR calculator one of several rental property calculators you should utilize when evaluating real estate projects and financing. By understanding this metric and it’s components, you will be more prepared when buying your next investment property.
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