Debt service coverage ratio: Difference between revisions

Revision as of 16:24, 17 August 2023

Revision as of 12:35, 27 November 2023

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{{Short description|Financial metric}}

{{tone|date=July 2022}}

The '''debt service coverage ratio''' ('''DSCR'''), also known as "debt coverage ratio" (DCR), is a financial metric used to assess an entity's ability to generate enough cash to cover its [[Debt|debt service]] obligations. These obligations include interest, principal, and lease payments. The DSCR is calculated by dividing the operating income available for debt service by the total amount of debt service due.

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

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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=January 2009}} but more aggressive banks would accept lower ratios, a risky practice that contributed to the [[Financial crisis of 2007–2010]]. 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 is commonly used to ensure that loan repayment can be met even in periods with DSCR<1.0 <ref name="Corality Financial Modelling">[http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio Corality Debt Service Coverage Ratio Tutorial]</ref>

==Calculation==

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For example, if a property has a debt coverage ratio of less than one, the income that property generates is not enough to cover the mortgage payments and the property's [[operating expense]]s. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt payments. However, if a property has a debt coverage ratio of more than 1, the property does generate enough income to cover annual debt payments. For example, a property with a debt coverage ratio of 1.5 generates enough income to pay all of the annual debt expenses, all of the operating expenses and actually generates fifty percent more income than is required to pay these bills.

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 /><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.