Debt service coverage ratio

The debt service coverage ratio, or debt service ratio, is the ratio of net operating income to debt payments on a piece of investment real estate. The higher this ratio is, the easier it is to borrow money for the property. The phrase is also used in corporate finance and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition, a loan covenant, or a condition of default.

1. In corporate finance, it is the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments.

2. In government finance, it is the amount of export earnings needed to meet annual interest and principal payments on a country's external debts.

3. In personal finance, it is a ratio used by bank loan officers in determining income property loans. This ratio should ideally be over 1. That would mean the property is generating enough income to pay its debt obligations.

4. In commercial real estate finance, this is the main measure to determine if a property will be able to sustain its debt based on cash flow. Most banks will lend to a 1.2 DSCR, but at times with more agressive practices you begin to see this number decreasing. A DSCR below 1.0 on a property indicates that there isnt enough cash flow to even cover the loan.Link title

In general, it is calculated by: DSCR = Net Operating Income / Total Debt service

A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.

Typically, most commercial banks require the ratio of 1.15 - 1.35 times (net operating income or NOI / loan amount) to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.