Debt service coverage ratio

The debt service coverage ratio (DSCR), also known as "debt coverage ratio" (DCR), is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition. Breaching a DSCR covenant can, in some circumstances, be an act of default.

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

In personal finance, DSCR refers to a ratio used by bank loan officers in determining debt servicing ability.

In commercial real estate finance, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow. In the late 1990s and early 2000s banks typically required a DSCR of at least 1.2, but more aggressive banks would accept lower ratios, a risky practice that contributed to the Financial crisis of 2007–2010. A DSCR over 1 means that (in theory, as calculated to bank standards and assumptions) the entity generates sufficient cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is not enough cash flow to cover loan payments. In certain industries where non-recourse project finance is used, a Debt Service Reserve Account is commonly used to ensure that loan repayment can be met even in periods with DSCR<1.0

In general, it is calculated by:

where:

To calculate an entity’s debt coverage ratio, you first need to determine the entity’s net operating income. To do this you must take the entity’s total income and deduct any vacancy amounts and all operating expenses. Then take the net operating income and divide it by the property’s annual debt service, which is the total amount of all interest and principal paid on all of the property’s loans throughout the year.

If a property has a debt coverage ratio of less than one, the income that property generates is not enough to cover the mortgage payments and the property’s operating expenses. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt payments. However, if a property has a debt coverage ratio of more than 1, the property does generate enough revenue to cover annual debt payments. For example, a property with a debt coverage ratio of 1.5 generates enough income to pay all of the annual debt expenses, all of the operating expenses and actually generates fifty percent more income than is required to pay these bills.

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