Question 1

What is the debt service coverage ratio (DSCR)?

Accepted Answer

DSCR measures whether a property's income covers its loan payments. The OCC's Comptroller's Handbook on commercial real estate lending defines it as net operating income divided by debt service. Fannie Mae's Multifamily Guide glossary defines it as the ratio of Net Cash Flow to the total of principal, interest and any required mezzanine or preferred-equity payments. A DSCR of 1.00 means the income exactly equals the payments, above 1.00 leaves a cushion and below 1.00 means the property cannot pay its own loan. Because Fannie Mae starts from its own Net Cash Flow figure, a lender's DSCR can differ from the simple NOI ÷ payments you get here.

Question 2

How is DSCR calculated?

Accepted Answer

DSCR = NOI ÷ annual debt service. NOI is the year's rent collected minus operating expenses, before loan payments and income tax. Annual debt service is 12 times the monthly payment. For an amortizing loan, the payment is the standard formula: loan × r ÷ (1 − (1 + r)^−n), where r is the monthly rate (annual rate ÷ 12) and n is the number of monthly payments. For an interest-only loan the payment is loan × annual rate ÷ 12. The "largest loan" mode runs the formula backwards: the payment you can afford is NOI ÷ target DSCR ÷ 12, and the loan is that payment divided by the payment on one dollar of loan.

Question 3

Worked example

Accepted Answer

A property has an NOI of $96,000 and a $1,000,000 loan at 7% over 30 years. The payment is $6,653 a month, or $79,836 a year, so DSCR = $96,000 ÷ $79,836 = 1.20. To reach a DSCR of 1.25 on that same loan the NOI would have to be $99,795. Run the other way: at a target of 1.25 the largest loan is $961,968; at 1.20 it is $1,002,050. These are example numbers, and 1.20 and 1.25 are only sample targets.

Question 4

What DSCR do lenders require?

Accepted Answer

It depends on the lender and the loan, and we did not find one figure that applies everywhere. Fannie Mae's Multifamily Guide does not print a number in the sections we read; it says the minimum DSCR is set per loan in its underwriting-standards form (Form 4660), so it varies with the loan type and tier. The Office of Thrift Supervision's 2009 examination handbook said savings associations generally required 1.20 or higher, depending on the property. HUD's FHA multifamily programs publish their own minimums in the MAP Guide and mortgagee letters, and those figures have changed over the years; we did not confirm the current number, so check HUD's current guide. Non-bank lenders that offer so-called DSCR loans on rental houses set their own terms, which are not standardized. Ask your lender for its minimum and for how it calculates NOI.

Question 5

How do rate and loan term change the loan you can get?

Accepted Answer

At the same NOI of $96,000 and a target of 1.25, a 7% rate allows a $961,968 loan over 30 years. At 6% it allows $1,067,466. Shortening the term to 20 years at 7% cuts it to $825,488, because each dollar of loan then costs more per month. An interest-only loan at 7% would support $1,097,143, which is why lenders look carefully at what happens when the interest-only period ends. Rate is the lever you cannot change after the loan is made; income is the one you can improve.

Question 6

What are the limits of DSCR?

Accepted Answer

First, it is only as good as the NOI behind it: lenders usually replace your vacancy, management and repair figures with their own, and may leave out income that is not documented, so the lender's NOI is often lower than yours. Second, it looks at one year and says nothing about rent growth, big repairs or a loan that resets to a higher rate. Third, it ignores the cash you put in, so it cannot tell you whether the investment is good; use the rental property calculator for cash flow, cap rate and cash-on-cash return. Fourth, it is not the same as the debt-to-income ratio, which compares a person's debts to personal income. Fifth, a DSCR near 1.00 is fragile: a small rise in vacancy or expenses pushes it below 1.00, which is why the break-even occupancy figure in the rental property calculator is worth checking too.

Question 7

What does a DSCR below 1.00 mean?

Accepted Answer

The property's net operating income is smaller than the loan payments, so the owner must cover the gap from other money every month. Most lenders will not lend on that basis without extra support, such as a bigger down payment, a lower loan amount or documented rent increases. Use the largest-loan mode to see how much debt the current NOI can carry at a given target.

DSCR calculator