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Calculate the Debt-Service Coverage Ratio
How Do You Calculate the Debt-Service Coverage Ratio (DSCR)?
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The DSCR is one of the most important ratios for lenders looking at borrowers’ repayment history. This is considering the income flow from the concerned property. It considers the amount of liquid cash available in the borrower’s account after servicing the loan. It compares that with the amount generated from a particular property as the net operating income. This is defined below:
DSCR Calculation:
DSCR=Net Operating Income (NOI) divided by Total Debt Service
Calculate Net Operating Income (NOI):
- NOI=Gross Rental Income−Operating Expenses
Example:
- Gross Rental Income: $120,000 per year
- Operating Expenses: $40,000 per year
NOI=120,000−40,000=80,000
That is: Total Debt Service Net Operating Income (NOI)
Net Operating Income (NOI): This is the income earned from renting the property out or from non-operational activity, less all expenses related to the gross income, less property taxes, which include property insurance, utilities (water, electricity, gas), and property management fees before any mortgage capital or interest is applied.
Total Debt Service:
The total of the loan payments, including interest and principal, made over a given period or during the loan’s life. Often, this comprises two annual mortgage dues.
Calculation Procedures in Order Likelihood:
Net Operating Income Calculation (NOI):
NOI Varies with net Rental Income
NOI=Gross Rental Income Operating minus Expenses NOI= Gross Rental Income minus Operating Income
Example: This made a few differences.
Annual gross rental Income: 120,000
Operating expenses: 40,000
NOI = 120,000− 40,000= 80,000
NOI=120,000-40,000=80,000
Calculation of Total Debt Service ( yearly installment payments): Total Debt Obligations
Total Monthly Loan Payments x 12: Total Debt Service
Example:
Monthly Loan Amount: 5000
Total Debt Service=5,000×12=60,000
Total Debt Service=5,000*12=60,000
Calculate Debt Service Coverage Ratio:
DSCR=80,000 divided by 60,000=1.33 is the DSCR
A degree of 1.33 indicates that the property can pay those obligations using its net income and still have a surplus of 33% more than required.
A DSCR of exactly one 1.0 indicates that the property generates just enough rent to pay off the debt with zero profit.
A DSCR of less than 1.0 signifies that the property needs to generate more cash flow from its operations, thereby raising the prospect of difficulty in obtaining a loan.
General DSCR Benchmarks:
1.25 or higher: Lenders usually require a DSCR ratio of 1.25 or higher on investment property loans to buffer volatile income or expenses.
Less than 1.0: In this case, the revenue from the property is less than the amount needed to be paid in loans. This is considered too risky. Such loans are normally declined, save for persons with mitigating factors.
Example DSCR Calculation:
In this scenario, you are analyzing a rental property.
Gross rental income: $120,000/year
Property operating expenses: $40,000/year
Annual debt service (Loan repayment) $60,000/year
NOI =120,000−40,000=80,000
NOI= 120,000 – 40,000 = 80,000
DSCR =80,000 divided by 60,000= 1.33
The above DSCR of 1.33 means safe coverage from the debt borrower’s payments. Hence, qualifying for a loan is easy.
If you need more help calculating the DSCR or want to know more about particular properties, you can always get in touch!