What is DSCR (Debt Service Coverage Ratio)?
DSCR is a metric used by lenders to determine loans on income-generating properties. It is the required cash flow for paying current debts (interest, principal, lease payments, etc.), plus a certain margin of safety. DSCR can be calculated by taking a property’s net operating income (NOI) and divid
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DSCR is a metric used by lenders to determine loans on income-generating properties. It is the required cash flow for paying current debts (interest, principal, lease payments, etc.), plus a certain margin of safety. DSCR can be calculated by taking a property’s net operating income (NOI) and dividing it by the property’s annual debt service. For HUD 223(f) loans, the minimum DSCR is 1.18x for market-rate properties, 1.15x for affordable properties, and 1.11x for rental assistance demonstration (RAD)/Section 8 properties.
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Related Questions
What is the definition of DSCR (Debt Service Coverage Ratio)?
DSCR (Debt-Service Coverage Ratio) is defined as the cash flow necessary to pay debts - interest, principal, lease payments, etc. It is used by lenders to determine loans on income properties. The ratio is a formula that divides the net operating income of a business by the total debt service amount:
DSCR = Net Operating Income / Total Debt Service
So, a business with a DSCR of less than 1 does not have sufficient funds to pay back debt obligations, while a business with a DSCR of greater than 1 does.
HUD 223(a)(7) loans are subject to a maximum DSCR of 1.11x (for-profit entities) or 1.05x (nonprofit entities).
How is DSCR (Debt Service Coverage Ratio) calculated?
DSCR can easily be calculated by using the formula below:
For instance, a commercial property with a net operating income of $1,000,000 and a debt service of $900,000 would have a DSCR of $1,000,000 / $900,000, or 1.11 (the income is 1.11x the annual debt service).
A debt service coverage ratio of 1 means a property is generating enough income to make its loan payments, while DSCR of less than 1 means it is not. Therefore, commercial lenders always want a project to have a DSCR higher than 1 to reduce the likelihood of a default or foreclosure. It’s important to realize that DSCR may change with manipulation of the loan terms, such as amortization, in order to increase or reduce annual debt service.
What is a good DSCR (Debt Service Coverage Ratio) for commercial real estate financing?
In most commercial real estate financing cases, lenders prefer properties with DSCRs of 1.25x or more, but a lender’s DSCR requirements depend on a combination of the borrower’s financial strength, the type of property, and other factors. For instance, while multifamily apartment properties may need a minimum DSCR of 1.20x to qualify for funding, riskier property types, such as hotels or self-storage facilities, may need a DSCR of 1.40x- 1.50x in order to qualify. Don’t expect to find many institutions willing to offer you a competitive loan at a DSCR of less than 1.25x.
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What are the benefits of having a high DSCR (Debt Service Coverage Ratio)?
Having a high DSCR (Debt Service Coverage Ratio) is beneficial for borrowers because it indicates that they have sufficient cash flow to cover their debt obligations. A DSCR of 1.25 or higher is often considered “strong” and is a good indicator that the borrower is in a good financial position. A high DSCR also makes it easier for borrowers to qualify for loans, as lenders typically require a minimum DSCR to qualify for a loan. Additionally, a high DSCR can help borrowers secure better loan terms, such as lower interest rates and longer repayment periods.
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What are the risks of having a low DSCR (Debt Service Coverage Ratio) for commercial real estate financing?
Having a low DSCR (Debt Service Coverage Ratio) for commercial real estate financing can be a sign that the borrower will have difficulty paying back the loan on time. In most cases, lenders prefer properties with DSCRs of 1.20x or more, though the required DSCR will typically depend on the financial strength of the borrower, the type of property in question, and other factors. For instance, while multifamily apartment properties may need a minimum DSCR of 1.20x to qualify for funding, riskier property types, such as hotels or self-storage facilities, may need a DSCR of 1.40x- 1.50x in order to qualify. Source