Debt Service Coverage Ratio (DSCR)

The debt service coverage ratio (DSCR) measures how many times a borrower's cash flow covers its loan payments. "Debt service" means the total principal and interest due over a period, usually a year.

The formula in words: DSCR equals cash flow available for debt service divided by total debt service.

For an income property, the cash flow figure is usually net operating income (NOI). For an operating business, lenders often start from EBITDA (earnings before interest, taxes, depreciation and amortization) and adjust for items like owner draws.

Worked example. A small office building produces NOI of $125,000 a year. The proposed loan has annual payments of $100,000. DSCR = $125,000 ÷ $100,000 = 1.25. The property earns $1.25 for every $1.00 of loan payments.

A DSCR of 1.00 means cash flow just covers the payments. Below 1.00, the borrower must find other money. Each lender sets its own minimum by loan type, higher for riskier properties or less stable income.

Why it matters for lenders

DSCR is the most common test of capacity: the borrower's ability to repay from ongoing income. Thin coverage leaves little room for a vacancy or a slow season. US bank examiners note that the right minimum depends on the amortization period and how much the cash flow swings. A hotel with uneven income warrants a higher ratio than a building leased long-term to a strong tenant.

DSCR also sizes loans. If policy requires 1.25 and the property earns $125,000, the most it can support is $100,000 a year in payments. At a given rate and term, that caps the loan amount. Some rental lenders go further and offer DSCR loans, which qualify the borrower on the property's coverage instead of personal income.

After closing, many loan agreements include a minimum DSCR as a loan covenant, tested each year or quarter. A drop below that level is an early warning sign.

How it works in practice

A bank underwrites a loan on a small retail center. The analyst uses the rent roll and operating statements to estimate NOI, then calculates DSCR at the proposed rate. She also runs a stress test: what if rates rise two percentage points at renewal, or the largest tenant leaves? Coverage falls to 1.05 in the worst case, so she recommends a smaller loan.

For owner-occupied loans, she may also build a global cash flow that adds in the owners' personal income and debts.

In a spreadsheet setup, someone must remember to request new statements each year and recompute the ratio. When the covenant, its formula and its test date sit on the loan, the system flags each test when it's due and shows the result.