Debt service coverage ratio: Difference between revisions

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{{Short description|Financial metric assessing ability to cover debt payments}}

{{tone|date=July 2022}}

The '''debt service coverage ratio''' ('''DSCR'''), also known as "the '''debt coverage ratio"''' ('''DCR'''), is a [[financial metricratio]] used tothat assessmeasures an entity's ability to generate enoughsufficient cash to cover its [[Debt|debt service]] obligations, such asincluding interest, principal, and lease payments. The DSCRIt is calculated by dividing the [[net operating income]] (NOI) by the total amountdebt ofservice. A higher DSCR indicates stronger cash flow relative to debt servicecommitments, duewhile a ratio below 1 suggests insufficient funds to meet payments.<ref name="investopedia2">{{cite web |title=Debt-Service Coverage Ratio (DSCR) |url=http://www.investopedia.com/terms/d/dscr.asp |access-date=March 31, 2025 |website=Investopedia}}</ref> Lenders, such as banks, often set a minimum DSCR in loan covenants, where falling below this threshold may constitute a [[Default (finance)|default]].

In [[corporate finance]], the DSCR reflects cash flow available for annual debt payments, including sinking fund contributions.<ref name="freedictionary2">{{cite web |title=Debt-Service Coverage Ratio - DSCR |url=https://financial-dictionary.thefreedictionary.com/Debt+service+coverage+ratio |access-date=March 31, 2025 |website=The Free Dictionary}}</ref> In [[personal finance]], it aids loan officers in evaluating an individual’s debt repayment capacity. In [[commercial real estate]], it determines whether a property’s cash flow can sustain its debt, with typical minimums around 1.25.<ref>{{cite web |last=Freitas |first=Taylor |title=What Is Debt-Service Coverage Ratio? |url=https://www.bankrate.com/loans/small-business/what-is-dscr/ |access-date=2024-01-30 |website=Bankrate}}</ref>

A higher DSCR indicates that an entity has a greater ability to service its debts. Banks and lenders often use a minimum DSCR ratio as a condition in covenants, and a breach can sometimes be considered an act of [[Default (finance)|default]].

==Uses Applications ==

The DSCR serves distinct purposes across contexts. In corporate settings, it assesses cash flow for debt obligations, while in personal finance, it evaluates borrowing capacity.<ref name="freedictionary2" /> In real estate, it’s a key indicator of property viability. During the late 1990s and early 2000s, banks often required a DSCR of at least 1.2,{{Citation needed|date=May 2024|reason=Does not have a reliable source}} though some accepted lower ratios, a practice linked to the [[2008 financial crisis]]. A DSCR above 1 indicates adequate cash flow, while below 1 signals potential shortfall. In project finance, a '''Debt Service Reserve Account''' ('''DSRA''') may offset periods where DSCR falls below 1.<ref name="Corality Financial Modelling2">{{cite web |title=Corality Debt Service Coverage Ratio Tutorial |url=http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio |url-status=dead |archive-url=https://web.archive.org/web/20130718014413/http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio |archive-date=2013-07-18 |access-date=2013-08-15}}</ref>

In corporate finance, DSCR refers to the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments.<ref name="freedictionary">[http://financial-dictionary.thefreedictionary.com/Debt-Service+Coverage+Ratio+-+DSCR DSCR finance term by the Free Online Dictionary]</ref>

In personal finance, DSCR refers to a ratio used by bank loan officers in determining debt servicing ability.

In commercial real estate finance, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow. In the late 1990s and early 2000s banks typically required a DSCR of at least 1.2,{{Citation needed|date=May 2024|reason=Does not have a reliable source}} but more aggressive banks would accept lower ratios, a risky practice that contributed to the [[2007–2008 financial crisis]]. A DSCR over 1 means that (in theory, as calculated to bank standards and assumptions) the entity generates sufficient cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is not enough cash flow to cover loan payments. In certain industries where non-recourse project finance is used, a Debt Service Reserve Account (DSRA) is commonly used to ensure that loan repayment can be met even in periods with DSCR<1.0 <ref name="Corality Financial Modelling">{{Cite web |url=http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio |title=Corality Debt Service Coverage Ratio Tutorial |access-date=2013-08-15 |archive-date=2013-07-18 |archive-url=https://web.archive.org/web/20130718014413/http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio |url-status=dead }}</ref>

==Calculation==

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In the commercial real estate industry, the minimum DSCR set by lenders is 1.25, meaning that the property's net operating income (NOI) is 25% greater than the annual debt service.<ref>{{Cite web |last=Freitas |first=Taylor |title=What Is Debt-Service Coverage Ratio? |url=https://www.bankrate.com/loans/small-business/what-is-dscr/ |access-date=2024-01-30 |website=Bankrate |language=en-US}}</ref>

A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.<ref name="freedictionary">[http://financial-dictionary.thefreedictionary.com/Debt-Service+Coverage+Ratio+-+DSCR DSCR finance term by the Free Online Dictionary]</ref><ref name="investopedia">[http://www.investopedia.com/terms/d/dscr.asp Debt-Service Coverage Ratio (DSCR) on Investopedia]</ref>

Typically, most commercial banks require the ratio of {{val|1.15|–|1.35}} {{tooltip|×|times}} {{pars|{{sfrac|{{abbr|NOI|net operating income}} | annual debt service}}|153%}} to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.

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*[[Operating leverage]]

*[[Project Finance]]

*[[Cash-flow-to-debt ratio]]

==References==