Debt Service Coverage Ratio
The Debt Service Coverage Ratio (DSCR) is a ratio used to analyze the amount of debt that can be supported by the cash flow generated from the property. Or, simply the net income generated by the property divided by the new commercial mortgage payment. The higher this debt service coverage ratio is, the easier it is to obtain a loan. This ratio is also referred to as the debt coverage ratio (DCR). While the debt service is the actual periodic payments (principal and interest) made during the of a loan.
DSCR = NOI / Debt Service
In commercial mortgage lending, the DSCR is equivalent to the debt-to-income (DI Ratio) in residential lending. Whereas in residential lending, the income and expenses used in the calculation are the borrower’s personal income and expenses, it’s the exact opposite in commercial mortgage lending. The income and expenses used in calculating the DSCR ratio are derived from the commercial property.
A common misconception made by borrowers when applying for a commercial mortgage loan is that the bank or commercial lender only uses the expenses from the property when calculating the NOI. Commercial lenders use the actual expenses plus additional line items, such as, off-site management, vacancy, replacement reserves, repairs and maintenance, etc. Commercial lenders add these numbers to the expenses should the borrower default. They must know the entire cost of taking back the property in event of a default.