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.
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.
Example 1: Good DSCR
If a property generates $12,000 in NOI per year and has $9,000 in annual debt service, your DSCR would be:
$12,000 ÷ $9,000 = 1.33
This means the property generates 33% more income than is needed to cover its debt payments, which is a good cushion for lenders and investors.
Example 2: Break-Even DSCR
If a property has $10,000 in NOI and $10,000 in debt service, the DSCR would be:
$10,000 ÷ $10,000 = 1.0
This means the property’s income just breaks even with its debt payments, which might raise concerns for lenders because there’s no margin for unexpected expenses.
Example 3: Negative DSCR
If a property generates $8,000 in NOI but has $10,000 in annual debt service, the DSCR would be:
$8,000 ÷ $10,000 = 0.8
This means the property is not generating enough income to cover its debt payments, which would make it a higher-risk investment for both you and the lender.
To simplify the process, The World’s Greatest Real Estate Deal Analysis Spreadsheet™ automatically calculates DSCR for you.
By entering your property’s income and expenses, the DSCR is computed on the Overrides tab in the Cash Flow section, allowing you to easily analyze deals without doing manual calculations.
This helps ensure your investment decisions are based on accurate and up-to-date information.
What is Considered a Good DSCR?
A “good” DSCR can vary depending on the lender and the type of property you’re financing, but there are some general benchmarks you can use as a guide.
Most lenders consider a DSCR of 1.25 or higher to be a solid number. This means the property generates 25% more income than is needed to cover its debt obligations.
A DSCR of 1.2 is often the minimum threshold for lenders, though some may require higher ratios, especially for riskier investments or commercial properties. For instance, a lender might prefer a DSCR of 1.5 for commercial real estate to ensure a strong buffer against economic downturns or unexpected expenses.
Lenders have different DSCR requirements based on the perceived risk of the property, market conditions, and the type of loan.
For example, a bank may require a lower DSCR for a residential property that’s in a stable market but demand a higher DSCR for commercial or multi-family properties, which can be more volatile.
A higher DSCR benefits both the lender and the investor.
- For lenders, a high DSCR reduces their risk by ensuring the property’s income comfortably covers the debt payments.
- For investors, it provides a cushion, reducing the likelihood that they’ll have to use personal funds to cover shortfalls if something goes wrong, like a sudden vacancy or unexpected maintenance costs.
However, there is a trade-off between DSCR and leverage.
Leverage allows investors to borrow more with a smaller down payment, which can boost returns on the capital they have invested—whether it’s their initial cash when analyzing a deal early on, or their equity when evaluating a property they’ve owned for a while.
By maximizing leverage, investors can improve their Return on Equity (ROE), as they’re getting more return from the smaller portion of money they have in the deal.
However, leveraging properties heavily can lower your DSCR because more debt increases your debt service obligations. While some investors prioritize keeping their ROE high through leverage, this often comes at the cost of a lower DSCR, which can raise risk and make securing financing more difficult—not just for the current property but also for future acquisitions.
Balancing DSCR and leverage is crucial for real estate investors who want to maximize portfolio performance while managing risk effectively.
How DSCR is Impacted if You Do an Interest-Only Loan
With an interest-only loan, you only pay the interest on the loan for a set period, without reducing the principal balance.
This can significantly reduce your monthly debt service during the interest-only period, leading to a higher DSCR and improving your ability to cover the loan payments with your property’s income.
Since interest-only loans require you to pay just the interest portion of the loan, your monthly debt service is lower compared to a fully amortizing loan, where each payment covers both interest and principal.
This means that during the interest-only period, your debt service is smaller, resulting in a higher DSCR because the property’s income doesn’t need to cover as much of the loan payment.
For example:
- Fully Amortizing Loan – A $200,000 loan at 5% interest over 30 years would have a monthly payment of about $1,073, covering both principal and interest.
- Interest-only loan – With the same loan, the interest-only payment at 5% would be approximately $833 per month, significantly lower than the fully amortized payment.
By having a lower monthly debt service, your DSCR improves during the interest-only period, increasing the property’s ability to comfortably cover its debt obligations.
Let’s compare the DSCR of an interest-only loan versus a fully amortizing loan.
- Loan Amount: $200,000
- Interest Rate: 5%
- Annual Net Operating Income (NOI): $16,000
Comparing the following two loan options (one interest-only and one fully amortizing):
- Fully Amortizing Loan – The monthly payment is $1,073. The annual debt service is $1,073 × 12 = $12,876. DSCR = $16,000 ÷ $12,876 = 1.24.
- Interest-Only Loan – The monthly payment is $833. The annual debt service is $833 × 12 = $9,996. DSCR = $16,000 ÷ $9,996 = 1.60
As you can see, the DSCR for the interest-only loan is higher at 1.60 compared to the 1.24 for the fully amortizing loan.
This is because the debt service is lower for interest-only loans, allowing the property to generate more cash flow and improving its ability to cover debt obligations.
While interest-only loans offer immediate cash flow benefits and a higher DSCR, they come with risks once the interest-only period ends.
Often, interest-only loans have balloon payments, meaning the entire loan balance becomes due at the end of the interest-only term. At that point, you’ll need to either refinance the property, pay off the loan balance from another source, or sell the property to cover the debt.
The challenge is that circumstances may not favor doing any of these options when the balloon payment is due:
- Refinancing – Interest rates might be higher at the time you need to refinance, increasing your debt service and potentially lowering your DSCR. Lenders could also tighten their requirements, making refinancing more difficult (or even impossible) to obtain.
- Paying Off the Loan – You may not have the available cash or access to another source of funds to pay off the loan.
- Selling the Property – The market may not be favorable for selling. Property values might have dropped, or it might not be the right time for you to exit the investment, forcing you to sell at a loss or miss out on future gains. And, if you’re considering selling because the options for financing your property are limited or non-existent that may apply to others as well making selling much more difficult.
Planning ahead for these potential challenges is essential when considering an interest-only loan.
Impact of Loan Terms on DSCR – 30 Year Versus 15 Year (Show Example)
The length of your loan term has a direct impact on your monthly debt service and, consequently, your DSCR.
- With a 30-year loan, the loan payments are spread over a longer period, which lowers your monthly payment and improves your DSCR.
- On the other hand, a 15-year loan will have higher monthly payments because you’re paying off the loan in half the time, which increases your debt service and lowers your DSCR.
A 30-year loan allows you to stretch out your principal payments over a longer period, significantly reducing your monthly debt service. This results in a higher DSCR because the property’s income doesn’t need to cover as much debt each month.
For example:
- 30-Year Loan – A $200,000 loan at 5% interest over 30 years results in a monthly payment of approximately $1,073.
- 15-Year Loan – The same $200,000 loan at 5% interest over 15 years results in a monthly payment of about $1,582.
As you can see, the 30-year loan has a lower monthly debt service, which would lead to a higher DSCR compared to the 15-year loan, which requires higher monthly payments.
- Loan Amount: $200,000
- Interest Rate: 5%
- Annual Net Operating Income (NOI): $16,000
30-Year Loan
- Monthly payment: $1,073
- Annual debt service: $1,073 × 12 = $12,876
- DSCR = $16,000 ÷ $12,876 = 1.24
15-Year Loan
- Monthly payment: $1,582
- Annual debt service: $1,582 × 12 = $18,984
- DSCR = $16,000 ÷ $18,984 = 0.84
In this example, the 30-year loan has a higher DSCR at 1.24 compared to the 15-year loan with a DSCR of 0.84.
The lower monthly payments on the 30-year loan give you more cash flow and a better ability to cover debt obligations, while the 15-year loan results in higher payments and a lower DSCR.
Both 30-year loans and 15-year loans pay off after 30 years and 15 years respectively, so you don’t have the same challenges that we discussed with interest-only loans.
Impact of Buying Down Interest Rates on DSCR
Buying down your interest rate can have a direct impact on your monthly debt service and, consequently, your DSCR.
When you buy down your interest rate, you pay an upfront fee, known as discount points, to reduce your loan’s interest rate. This lowers your monthly payments, which improves your DSCR because your debt service is reduced.
A lower monthly debt service means more of the property’s income is available to cover other expenses or to increase your cash flow.
For example:
- At 5% Interest Rate – A $200,000 loan at 5% interest results in a monthly payment of approximately $1,073.
- At 4.5% Interest Rate – If you buy down the interest rate to 4.5%, the monthly payment drops to about $1,013.
As you can see, the lower interest rate results in a smaller debt service, which leads to a higher DSCR.
Let’s compare the DSCR with and without the rate buy-down:
- Loan Amount: $200,000
- Annual Net Operating Income (NOI): $16,000
At 5% Interest Rate
- Monthly payment: $1,073
- Annual debt service: $1,073 × 12 = $12,876
- DSCR = $16,000 ÷ $12,876 = 1.24
At 4.5% Interest Rate
- Monthly payment: $1,013
- Annual debt service: $1,013 × 12 = $12,156
- DSCR = $16,000 ÷ $12,156 = 1.32
In this example, buying down the interest rate improves the DSCR from 1.24 to 1.32. The lower debt service gives the property more cash flow, increasing your ability to cover debt obligations.
Not only does this improve cash flow on the property, but it can also help you qualify for future loans. DSCR lenders often look at the DSCR across your entire portfolio, not just the property you’re purchasing.
Having properties with better DSCRs strengthens your portfolio, which can make it easier to scale into additional investments. Buying down your rate can be a smart way to improve DSCR and position yourself for long-term growth.
DSCR vs. Other Financial Metrics
When evaluating real estate deals, investors use various metrics to assess a property’s performance.
DSCR is important for understanding how well a property can cover its debt, but metrics like Cash on Cash Return on Investment, Cap Rate and the overall Return on Investment/Return on Equity offer other insights.
- DSCR (Debt Service Coverage Ratio) measures how well a property’s income covers its debt payments. It focuses on the property’s Net Operating Income (NOI) compared to its annual debt service. This gives a clear picture of how comfortably the property can handle its loan payments.
- Cash on Cash Return on Investment is different. It measures the cash flow part of the return on the actual cash invested in the property. It’s calculated by dividing annual cash flow (after debt service) by the total cash you invested, like the down payment, closing costs, rent ready costs (and cumulative negative cash flow if applicable). Cash on Cash focuses on your return as an investor, rather than the property’s ability to cover its debt.
A property with a high DSCR could still have a lower Cash on Cash Return if you made a large down payment.
On the flip side, a property with a lower DSCR could show a high Cash on Cash Return if you’re using leverage to boost your returns, even though the debt service is more challenging.
- Cap Rate is calculated by dividing NOI by the property’s purchase price, showing the return if you bought the property without financing. While Cap Rate focuses purely on the property’s performance, DSCR factors in the impact of debt and financing. For example, Cap Rate evaluates the property’s profitability without considering loan payments, while DSCR shows whether the property’s income can comfortably cover those payments.
- Overall Return on Investment (ROI) or Return on Equity (ROE) measure the overall return on an investment, taking into account appreciation, cash flow, debt paydown, and tax benefits. While DSCR focuses on the property’s ability to cover debt, ROI and ROE gives you a broader picture of profitability, including factors beyond income and debt.
Lenders focus on DSCR because it helps them gauge the risk of a loan. A higher DSCR means the property generates enough income to cover its debt comfortably, reducing the likelihood of default.
That’s why lenders often require a minimum DSCR, typically 1.2 or higher.
For investors, DSCR may not always be the main focus.
While it’s important for knowing if the property can support its debt, many investors focus more on metrics like Cash on Cash Return on Investment, Cap Rate, Return on Investment and Return on Equity to gauge overall profitability.
Investors might accept a lower DSCR if it means achieving higher Cash on Cash Returns or a better overall Return on Investment or Return on Equity, which includes factors like appreciation, debt paydown, cash flow, and tax benefits.
These metrics are often in direct conflict.
Maximizing leverage to boost overall returns can lower DSCR because it raises your debt payments. While DSCR ensures the property can cover its debt, focusing on maximizing returns through leverage often involves accepting more risk by reducing the buffer for debt coverage.
In the end, DSCR is only one tool among many for evaluating a property’s overall performance.
See also Ultimate Guide to Cap Rate vs Cash on Cash Return on Investment for more details.
DSCR-Based Loans for Real Estate Investors
DSCR loans are a type of real estate loan specifically designed to evaluate a property’s ability to cover its debt service.
Unlike traditional loans, which may focus more on the borrower’s personal income and creditworthiness, DSCR loans focus on the property’s income-generating potential.
In this case, the lender’s primary concern is whether the property’s Net Operating Income (NOI) is sufficient to cover the mortgage payments (debt service).
How DSCR Loans Differ from Traditional Loans
In a traditional loan, factors such as your personal income, employment history, and debt-to-income ratio play a significant role in determining whether you qualify.
DSCR loans, however, rely on the property’s DSCR to make this decision.
As long as the property’s income can sufficiently cover the loan payments, the borrower’s personal income may be less scrutinized.
Typical Use Cases for DSCR Loans
DSCR loans are often used by real estate investors who want to scale their portfolios but may not have traditional sources of income that qualify them for standard loans.
These loans are also commonly used for investment properties such as single-family rentals, multi-family buildings, and short-term rental properties, where the property’s income is a central consideration in loan approval.
Advantages and Disadvantages of DSCR Loans
Here are some of the advantages of DSCR loans:
- Flexible Qualification – DSCR loans focus more on the property’s income, so you don’t need to meet the strict personal income and employment requirements of traditional loans.
- Faster Approval – Since the loan is based on the property’s income, the approval process can often be quicker and less cumbersome.
- Scalability – These loans make it easier for investors to qualify for financing across multiple properties, even if their personal debt-to-income ratio is maxed out.
- More Flexible Down Payment Sourcing – In some cases, lenders are more flexible with the source of down payments; for example, you may be able to borrow the down payment from a private lender as long as you’re still below the DSCR threshold.
And, here are some of the disadvantages of DSCR loans:
- Higher Interest Rates – Because DSCR loans focus more on the property than the borrower’s personal financial history, they often come with slightly higher interest rates than traditional loans to account for the perceived risk.
- Larger Down Payments – Some lenders may require higher down payments (typically around 25%) to mitigate the risk.
- Stricter Property Performance Requirements – Lenders may demand higher DSCR thresholds to ensure that the property’s income is reliable enough to cover the loan payments comfortably.
Common Requirements for Qualifying for DSCR Loans
To qualify for a DSCR loan, you typically need:
- A minimum DSCR ratio, usually between 1.2 to 1.5, depending on the lender and property type.
- A larger down payment, often around 20-30% of the property’s purchase price.
- Good credit (though the emphasis is on the property’s performance, most lenders will still require a reasonable credit score, typically 620 or higher).
- Reliable rental history or projected income to demonstrate the property’s ability to generate cash flow.
DSCR loans offer a great alternative for real estate investors who may not qualify for traditional financing, but they come with trade-offs, including higher costs and stricter property income requirements.
Typical DSCR Requirements for Different Property Types
DSCR requirements vary depending on the property type because different asset classes carry different levels of risk. Lenders adjust the minimum DSCR to ensure the property generates enough income to cover its debt service comfortably.
Here’s a quick summary of how DSCR requirements typically differ across property types:
- Residential Properties (Single-Family) – DSCR requirements are usually 1.2 to 1.25. Residential properties are lower-risk, with more predictable cash flow and tenant demand.
- Multi-Family Properties (5+ Units) – DSCR is typically 1.25 to 1.35. These properties are more stable due to multiple tenants but require higher DSCR to account for management complexity and potential vacancy.
- Commercial Properties – DSCR requirements are generally 1.3 to 1.5+. Commercial properties carry more risk due to volatile cash flows and longer vacancy periods, so lenders require a larger income cushion.
Lenders impose stricter DSCR thresholds on higher-risk properties to ensure there’s enough buffer to cover debt, even if income fluctuates.
Strategies for Increasing NOI and Boosting DSCR
You can improve your DSCR by increasing the income from your property or by reducing expenses—both of which impact your Net Operating Income (NOI)—or by reducing your debt payments.
We’ve already touched on ways to reduce debt payments, so let’s briefly focus on improving income. For a deeper dive, be sure to check out our other resources on improving cash flow, but I want to highlight a couple of the more extreme examples: short-term rentals and student rentals.
Both of these strategies can significantly increase NOI compared to traditional rentals. Short-term rentals, such as Airbnb properties, can bring in much more income by charging nightly or weekly rates. Student rentals, on the other hand, often allow you to rent by the room, generating more revenue than a traditional single-unit lease.
Let’s compare the DSCR for a traditional rental, a student rental, and a short-term rental.
Loan Amount: $200,000
Interest Rate: 5%
Annual Debt Service: $12,876
Here’s an example of the potential NOI for each type:
- Traditional Rental: Annual NOI = $16,000
- Student Rental: Annual NOI = $20,000
- Short-Term Rental: Annual NOI = $28,000
Based on these numbers, the DSCR for each would be:
- Traditional Rental: DSCR = $16,000 ÷ $12,876 = 1.24
- Student Rental: DSCR = $20,000 ÷ $12,876 = 1.55
- Short-Term Rental: DSCR = $28,000 ÷ $12,876 = 2.17
To summarize:
- A traditional rental has the lowest DSCR at 1.24, which is acceptable but leaves little cushion.
- The student rental improves DSCR to 1.55, offering stronger income relative to debt payments.
- The short-term rental dramatically increases DSCR to 2.17, providing a much larger margin for covering debt service and significantly improved cash flow.
By adopting high-cash-flow strategies like these, you can significantly boost DSCR, reduce risk, and better position yourself to scale your portfolio.
Using DSCR for Long-Term Financial Planning
The Debt Service Coverage Ratio (DSCR) is a valuable tool for long-term financial planning in real estate investing.
DSCR also plays a crucial role in determining when to refinance or sell properties.
- If your DSCR is high, it may indicate favorable conditions for refinancing—especially if you’re able to get a lower interest rate.
- Conversely, if DSCR is stalling or declining, it may be a sign that selling the property could be a better option.
Of course, check out our additional resources on should I sell or refi my rental property because there are a lot of other, additional calculations and considerations.
It is common to calculate DSCR on a per-property basis and also on a portfolio basis. Lenders often look at both.
- Per-Property DSCR – Evaluating DSCR on a per-property basis allows you to assess the risk and performance of each asset in your portfolio. This individual analysis helps you identify underperforming properties that may require attention or divestment.
- Portfolio DSCR – On a broader scale, assessing DSCR across your entire portfolio provides a comprehensive view of your overall financial health. This holistic approach enables you to make strategic decisions about scaling, refinancing, or selling properties. A low average DSCR across your portfolio may indicate higher risk, prompting a reevaluation of your investment strategies.
DSCR is also a measure of risk for your portfolio.
It allows you to compare different real estate investing strategies. For instance, one strategy may yield a higher (lower risk) DSCR, while another may start with a lower (higher risk) DSCR but improves over time. Analyzing these metrics can help you decide which strategy to use to achieve financial independence with real estate.
Additionally, our concept of Resilience ties directly into DSCR. As an example, Rent Resilience™ is defined as how much can rent drop before you have negative cash flow on a rental property. This is a slightly different way to measure the same thing as DSCR as it gives you a different way of thinking about the relationship between income and expenses on the property.
We have additional resources available on measuring and evaluating risks of investing in real estate, providing further insights on how to manage and mitigate risks effectively while optimizing your investment strategy.