DSCR Formula and Calculation

By Bill Lyons | Published on September 15, 2022

“No tax returns needed! No income verification! Use your rental income to finance your investment properties!”

Have you seen ads promising easy funding from DSCR loans? In truth, there is nothing magical about the DSCR (debt-service coverage ratio). But it’s an important measure of the financial stability of a real estate investment project and your long-term ability to repay it.

In this article, we will explain the DSCR formula and calculation and what you can do if your DSCR isn’t yet up to your lender’s standards. We will also answer some frequently asked questions about getting and using DSCR loans.

What is the debt service coverage ratio?

The debt-service coverage ratio is a single number that measures your readiness for DSCR loans. Your lender uses it for a quick look at whether you can service your current debt and any other debt they help you take on.

The DSCR is a cash coverage ratio. It measures how many times you can payyour mortgage payment including principal,interest, taxes, and insurance (HOA if applicable) on your DSCR loan from your gross rental income. It tells the lender whether you have sufficient income to cover additional debt.

Ideally, your DSCR needs to be greater than 1. A DSCR lower than 1 indicates that you won’t have the cash to service new debt. A DSCR of exactly 1 indicates that you are keeping up with your current obligations, but you aren’t able to take on any new debt with a cashout refinance.

Most lenders look for a DSCR of at least 1.25

Most lenders use a DSCR formula and calculation like this:

Annual Rental Income ÷ Annual Mortgage Payments = DSCR, aka Debt Service Coverage Ratio

A few commercial lenders use EBIT (earnings before interest and taxes) for their DSCR formula and calculation for both commercial loans and real estate investment loans for LLCs:

Earnings Before Interest and Taxes (EBIT) ÷ Annual Debt Payments = DSCR

Using EBIT to calculate your debt service coverage ratio gives you a higher number and a greater chance for getting a loan (something you may point out to a loan officer if you are told you are on the bubble for getting a loan).

Where do you get the numbers to plug into the DSCR formula?

For lending purposes, here’s how you come up with DSCR:

Gross Revenue / Rent – Mortgage Payment(s) = DSCR

If you use accounting software, your P & L (Profit and Loss) Statement will have a line item with this number.

You will also need to know your total debt payment for the year. If you are using accounting software, you can find this number in your general ledger. But if you need to calculate your total debt payment manually, the formula is:

Principal Payment + Interest Payment + Tax Payment + Insurance Payment = Total Debt Payment

You don’t have to wait for a lender to do your DSCR calculation. You can calculate it yourself. This way, you will know whether you need to decrease expenses or increase your revenues to qualify for a DSCR loan. Let’s look at a few examples.

Debt service coverage ratio example

Ready to calculate your DSCR?

First, access your year-end income statement to find your gross rental income. To keep the math simple in this example, let’s say that your gross rental income was $120,000.

Your next step is to calculate your annual debt service, the total mortgage debt you pay every year, including principal, interest, taxes, insurance and HOA (if applicable). Again, to keep the math simple, let’s suppose you have a $500,000 mortgage on your real estate property and no other debt. You make total piti mortgage payments of $5,000 a month

Now, multiply your monthly debt service by 12 months to get your annual debt service:

$5,000 X 12 = $60,000

Next, divide your gross rental income by your annual debt service:

$120,000 ÷ $60,000 = 2

In this example, your DSCR is 2. Most lenders would consider this to be a very good number. The question, however, is what will your DSCR be after you get a new loan?

In this example, let’s suppose you want to expand your building. The expansion will cost $500,000. Your lender will consider financing the entire cost of the expansion at 5% simple interest (interest only) with an APR of 5.843% on a 6 Month SOFR ARM DSCR loan. Again, to keep the math simple, let’s suppose your additional monthly payment would be $5,000.

You currently have debt service of $60,000. If you get the loan, you will have additional debt service of

$5,000 x 12 = $60,000

Now, compute the new total annual debt service on your investment property.

$60,000 + $60,000 = $120,000

And compute your new DSCR.

$120,000 ÷ $120,000 = 1

Your computed DSCR tells your lender that you could just make your payments with breakeven cashflow..

What is a good DSC ratio?

The best way to describe a good DSC ratio is “it depends.”

A DSC ratio of 1.25 to 1.50 (after the new loan is added in) tells your lender that you are a good risk. You have a cash cushion that you can use to be sure you make all your payments. How close to 1.25 or 1.50 the lender is willing to go depends on several factors:

• The competitiveness of the loan market. When lenders have more cash than they have customers borrowing, they are usually willing to take a bigger risk—for which they charge a higher interest rate.
• The prospects for your business. All successful entrepreneurs believe in their businesses. But if you can show a solid history of long-term lease agreements or Airbnb / VRBO short-term rental receipts that support a pattern of growth, the lender is more likely to give you the financing you need to keep growing.
• The lender’s view of the prospects for the local, state, and national economy. When lenders believe that the economy is headed for a downturn, they are less likely to lend money. When lenders are bullish on growth prospects, they are more likely to lend money even if you have a lower DSCR.

Even the most calculating lenders sometimes work from hunches or give weight to your reputation, or demonstrated good character. But don’t expect charisma or salesmanship to always trump math.

A computed DSC ratio below 1 means that there is no reasonable expectation that you could keep up with your payments. That doesn’t mean that there is absolutely no way you could get a DSCR loan. But your lender may require you to put down a larger down payment of 30% or more to make sure you have the cash at least to pay interest, even when you can’t pay the principal. (Note: If your DSCR is below 1 on a cashout refinance, the lender will only allow you to go up to 60% loan-to-value and leave 40% in equity in the property.)

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What can I do if my DSCR is below 1?

When your DSCR comes back low, there are things you can do to get your financial act together:

• Pay down existing debt. Reducing or, better, eliminating existing loan payments raises your DSCR and makes approving your loan more likely. This means you will have to wait before you can get a DSCR loan, but you will get your additional financing at a lower rate of interest.
• Increase rents. The market can justify you increasing rents on your tenants or can you make improvements to the property toincrease profitability to qualify for a DSCR loan. 
• Refinance. Refinance to a lower fixed rate mortgage, longer loan term, interest-only DSCR mortgage loan, and/or an adjustable-rate mortgage (ARM)

Don’t borrow more money than you are comfortable owing. Use your DSCR to establish your personal comfort zone with rental property debt.

How do I calculate DSCR in Excel for lending purposes?

First, create the column and row heading names. Give the sheet the title “Calculating DSCR.” Then, enter column headings:

• A2 = Company Name
• B2 = Gross Rental Income
• C2 = Total Debt Service
• D2 = DSCR

Enter your company’s name in A3. Enter Gross Rental Income in B3 and Total Debt Service in C3.

The lender’s formula for DSCR is Gross Rental Income ÷ Total Debt Service, so you will enter

=B3/C3

in D3. Excel will compute the DSCR from the data you enter. You can repeat the process for as many rows as you like if you have more than one company.

Griffin Funding can provide DSCR commercial loans

When you are investing in commercial real estate, you need a business-purpose commercial loan. Griffin Funding offers competitive rates with flexible underwriting options to help more borrowers start investing and grow their portfolios. Learn more about our residential DSCR loan and commercial real estate loan requirements and why you should consider Griffin Funding as your lender. Call us today at 855-698-1098.

Bill Lyons

Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.