Also known as Debt Service Coverage Ratio (DSCR). The debt overage ratio is a widely used benchmark which measures an income producing property’s ability to cover the monthly mortgage payments. The DCR is calculated by dividing the net operating income (NOI) by a property’s annual debt service. Annual debt service equals the annual total of all interest and principal paid for all loans on a property. A debt coverage ratio of less than 1 indicates that the income generated by a property is insufficient to cover the mortgage payments and operating expenses. For example, a DCR of .9 indicates a negative income. There is only enough income available after paying operating expenses to pay 90% of the annual mortgage payments or debt service. A property with a DCR of 1.25 generates 1.25 times as much annual income as the annual debt service on the property. In this example, the property creates 25% more income (NOI) than is required to cover the annual debt service.

Example: We are considering buying an investment property with a net operating income of $24,000 and annual debt service of $20,000. The DCR for this property would be equal to 1.2. This means that it generates 20% more annual net operating income than is required to cover the annual mortgage payment amount.

Many lending institutions require a minimum debt coverage ratio value to procure a loan for income producing properties. DCR requirements for lending institutions may vary from as low as 1.1 to as high as 1.35. From a lending institutions perspective, the higher the debt coverage ratio value, the more income there is available to cover the debt service and thus the less the risk.

Net Operating Income (NOI) is calculated as follows.

Operating Expenses include the following items; advertising, insurance, maintenance, property taxes, property management, repairs, supplies, etc. Lenders use the debt coverage ratio to determine if an income producing property has sufficient income to cover the operating expenses and debt service. To acquire a loan for an income producing property, the debt coverage ratio must usually be greater than 1.1 and most lenders require a debt service coverage ratio greater than 1.2.