Debt Service Coverage Ratio for Real Estate Investors

Bonus Module

If you're serious about investing in real estate, understanding how to evaluate a property's ability to cover its debt is essential. That's where the Debt Service Coverage Ratio (DSCR) comes in.

Mastering DSCR can mean the difference between getting approved for financing or missing out on the deal. It’s also a key metric that can guide your deal analysis, decision-making and long-term success.

Let’s uncover how lenders use DSCR to evaluate deals, how it stacks up against other metrics, and how you can improve it. Whether you're buying your first property or expanding your portfolio, DSCR will become your go-to tool for assessing risk and profitability.

Table of Contents

Included in this module:

• Introduction to Debt Service Coverage Ratio (DSCR)

• How DSCR is Calculated

• What is Considered a Good DSCR?

• How DSCR is Impacted if You Do an Interest-Only Loan

• Impact of Loan Terms on DSCR - 30 Year Versus 15 Year (Show Example)

• Impact of Buying Down Interest Rates on DSCR

• DSCR vs. Other Financial Metrics

• DSCR-Based Loans for Real Estate Investors

• Typical DSCR Requirements for Different Property Types

• Strategies for Increasing NOI and Boosting DSCR

• Using DSCR for Long-Term Financial Planning

Introduction to Debt Service Coverage Ratio (DSCR)

The Debt Service Coverage Ratio (DSCR) is a key metric you’ll want to understand as a real estate investor.

It tells you how well a property’s income covers its debt obligations.

In other words, it helps you see if the money a property generates is enough to cover the mortgage payments.

For real estate investors, DSCR is especially important because it shows lenders whether a property is a solid investment. They want to know that the property can pay for itself without you needing to dip into personal funds. That’s why DSCR is a common tool lenders use to assess risk and decide whether or not to approve a loan.

The formula for calculating DSCR is straightforward: Net Operating Income (NOI) divided by Debt Service.

NOI is the income left after you subtract operating expenses, and debt service is the total of your mortgage payments, including principal, interest, taxes, insurance, and PMI if applicable.

So, if your annual NOI is $10,000, and your annual debt service is $8,000, your DSCR would be 1.25.

Lenders like DSCR because it provides a clear snapshot of the property’s ability to cover its debt.

A higher DSCR means there’s more cushion between the property’s income and its loan payments, which lowers your risk (and the lender’s risk).

DSCR also plays a key role in scaling your real estate portfolio. If your properties consistently have strong DSCRs, lenders may be more willing to finance additional deals. This can help you grow your portfolio faster and with less friction. Conversely, if your DSCR is low, it could limit your ability to secure new financing and slow down your investment growth.

That’s why it’s critical to understand and monitor this ratio when evaluating potential real estate deals.

How DSCR is Calculated

The Debt Service Coverage Ratio (DSCR) is calculated by dividing a property’s Net Operating Income (NOI) by its Debt Service.

Net Operating Income (NOI) is the property’s total income after subtracting all operating expenses, which gives you a clear picture of how much cash flow the property produces from its day-to-day operations.

To calculate NOI, start by adding up all sources of income. This typically includes rental income, fees charged to tenants (such as late fees or pet fees), and any other income streams like coin-operated laundry or parking fees. Don’t forget to account for a reasonable vacancy allowance, which reflects potential lost income due to unoccupied units.

Next, you subtract operating expenses.

These include property taxes, property insurance, HOA fees, landlord-paid utilities, maintenance and repairs, property management fees, and any other costs directly tied to running the property. It’s important to note that loan payments (principal and interest) are not part of operating expenses, so they don’t factor into the NOI calculation.

Debt Service is the total amount you pay annually toward your mortgage. This includes principal, interest, property taxes, insurance, and PMI (Private Mortgage Insurance), if applicable.

The formula for DSCR is simple: NOI ÷ Debt Service.

Examples

Here are three examples: one with a good DSCR, one that breaks even, and one where the income from the property does not cover the debt service.