DSCR stands for “Debt Service Coverage Ratio.” It’s a measure used primarily by lenders to determine the cash flow available to service a borrower’s debt. It’s especially prevalent in commercial real estate financing, but it can be applied to any business or individual who has taken on debt.
- Net Operating Income (NOI) is the total income from a property or business minus all operating expenses (not including debt service).
- Total Debt Service is the annual principal and interest that the borrower must pay.
Here’s a brief breakdown of the formula:
DSCR > 1.0: This means there is more income than is required to service the debt. A DSCR of 1.2, for instance, indicates there’s 20% more income than is necessary to pay the debt. Lenders generally prefer a DSCR over 1 because it shows a cushion against potential downturns in the borrower’s revenue stream.
DSCR = 1.0: This means income is exactly equal to the debt service. There’s no room for error here; any drop in income might lead to a default.
DSCR < 1.0: This indicates the entity doesn’t generate enough income to cover its debt obligations, which is a red flag for lenders.
When you refer to a “DSCR Loan,” it likely means a loan where the lender has evaluated the borrower’s ability to repay the loan using the DSCR metric. Lenders often have a minimum DSCR threshold for approving loans to ensure that the borrower can comfortably handle the debt.
For example, if a lender requires a DSCR of 1.25 for a commercial property loan, then the property’s NOI must be 1.25 times the annual debt service for the borrower to qualify for the loan.
It’s worth noting that while DSCR is an important metric, it’s just one of many criteria lenders look at when deciding whether to issue a loan. They’ll also consider the borrower’s creditworthiness, the value of the underlying asset, the economic outlook, and other factors.
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