Calculation

• The debt coverage ratio, often called the debt service coverage ratio, or DSCR, equals annual net operating income of an income property divided by annual mortgage payment or debt service. Net operating income, or NOI, equals gross income minus operating expenses.
  
  As an example, a property with annual NOI of $125,000 and annual mortgage payment of $100,000 has a debt coverage ratio of 1.25: $125,000 / $100,000 = 1.25.
  
  

Interpretation

• A debt coverage ratio greater than 1.0 means the property generates more than enough income to make the mortgage payment. A ratio equal to 1.0 shows there's exactly enough income to make the payment. A debt coverage ratio less than 1.0 means the property is not producing enough income to pay the loan and may force the borrower to come up with an another source of money to make the mortgage payment or default on the loan.
  
  

Determine Mortgage Payment

• Borrowers also can use the debt coverage ratio to estimate the size of the mortgage payment they might qualify for when purchasing or refinancing an income property.
  
  For example, if a lender requires a minimum debt coverage ratio of 1.2 and an income property has an annual net operating income of $60,000, divide NOI by the debt coverage ratio to determine the borrower may qualify for a $50,000 annual mortgage payment: $60,000 / 1.2 = $50,000.
  
  

Lender Requirements

• The debt coverage ratio varies between lenders and property types depending on various risk factors. During times of economic growth, lenders may be more comfortable with a lower debt coverage ratio than during economic uncertainty. Lenders typically want a cushion in case NOI turns out to be less than expected, and they generally require a minimum debt coverage ratio of about 1.2.