Debt Service Coverage Ratio loan for Investors
Published 7 months ago
Debt service coverage ratio – or DSCR – is a metric that measures the borrower’s ability to service or repay the annual debt service compared to the amount of net operating income (NOI) the property generates.
DSCR indicates whether or not a property is generating enough income to pay the mortgage. Lenders use the debt service coverage ratio as one measurement to determine the maximum loan amount when a real estate investor is applying for a new loan or refinancing an existing mortgage.
The larger the DSCR ratio is, the more net operating income there is available to service the debt.
HOW REAL ESTATE INVESTORS USE DSCR
Let’s assume an investor is thinking about purchasing a rental property with an asking price of $150,000.
Prior to making an offer, the investor connected with a lender partner and learned that the lender will require a DSCR of 1.40.
If the property is generating an NOI of $7,500, the investor can use the DSCR formula to calculate the amount of annual debt service the lender will allow, and the down payment needed to purchase the property.
The first step is to rearrange the debt service coverage ratio formula to calculate the maximum allowable mortgage payment:
DSCR = NOI / Debt Service
Debt Service = NOI / DSCR
$7,500 NOI / 1.40 DSCR = $5,357 Debt Service (principal and interest)
After consulting with the lender, the investor learns a down payment of 30% will be needed to purchase the rental property at the asking price in order to meet the lender’s requirement for a DSCR of 1.40.
An investor can utilize the DSCR formula when shopping around in some of the best markets for rental property.
For example, assume an investor has set aside $25,000 in capital to be used as a down payment, and the lender requires a debt service coverage ratio of 1.35. The investor can now look for rental homes for sale across the country that meet the investor’s down payment allocation and the lender’s DSCR requirements.
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