How to Calculate Debt Service Coverage Ratio (DSCR)

What is Debt Service?

Debt service is the amount of cash required to pay the interest expense and the principal on a loan during a specific period of time. If a company or an individual is taking out a loan, the borrower needs to calculate their debt service on the loan. Specifically, the debt service ratio determines if the borrower has the ability to pay back the loan. Likewise, the lender also calculates debt service to ensure that the borrower will be able to pay back the loan and not default.

DSCR – Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) is the measure of available cashflow to pay current debt commitments during a given period. This ratio can be used to analyze projects or finances. The DSCR measures the net operating income compared to its current debt obligations. In general, a good debt service coverage ratio is above a 1.0x. A 1.0x ratio means that the project makes just enough cashflow to cover the debt obligations exactly. Anything higher is an optimal debt service and anything lower will throw up red flags for lenders. Lenders want to see that an individual or a company can pay back their loan easily. Typically, if a project is going through a construction or renovation period the debt service (on a monthly basis) will be lower until the construction or renovation is complete.

How to Calculate Debt Service

The DSCR formula is as follows:

where the NOI, or net operating income, is the sum of the revenues and expenses during a specified period and the debt service is the interest plus the principal payment during the same period. By using this formula, one can calculate the ability to pay back a loan.

In order to be as accurate as possible, one will need refer to the specific loan documents to understand how the lender is calculating the NOI. For example, the lender might annualize the trailing twelve months, annualize the trailing three months, annualize the trailing one month, or look at the forward NOI.

Conclusion

The debt service coverage ratio represents the capacity to repay a loan. It measures the cashflows compared to the interest and principal repayment. The DSCR formula is an important calculation used by both the borrower and lender to determine if the borrower should apply for a loan and even more, be approved.

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About the Author

Eric Bergin is the founder of TSM. He realized that there was a need for real estate financial models that were more than just generic templates. He wanted to create a personalized product for his customers that would ensure success for them and their company. Please reach out to him if you have any questions regarding DSCR or if he can help you with your modeling needs.