Even though the title of this blog post is DSCR (Debt Service Coverage Ratio), we will use this opportunity to explain both DSCR and DTI (Debt To Income Ratio), as they are both important concepts around debt financing calculations.

First, let’s check out the formula for DSCR:

DSCR = NOI / Total Debt Service

We already had a previous blog post that talked about NOI, which you may read it here. When it comes to “Total Debt Service,” that basically means your total mortgage balance, plus any possible private money fund, or “borrow from my parents” funds, that do not necessarily show up on your credit report. If you are “borrowing” that money, that should be factored into the “Total Debt Service” column.

As a finance indicator, the DSCR is quickly measured at the tipping point of 1.0x. (Yes, we usually put an “x” at the end, to represent “times”, like in this case it is 1.0 time.) If the DSCR is > 1.0, that means we have enough income to cover the debts, which is a good sign. If the DSCR is < 1.0, that means we do not have enough income to cover the debts, which usually is a bad sign. What we would like to strive for, is a DSCR of 1.2x, because that gives us some cushion in case the NOI decreases due to short term tenant turnovers.

When you go to lenders to obtain financing for your next real estate investment, it is very common that they will ask for the DSCR. The very simple reason is that the lenders will want to make sure your property generates enough income to at least pay the mortgage each month. So before approaching any lender, you can save yourself some trouble by pre-calcuating the DSCR and making sure it is at least 1.2x or above.

Next, let’s talk about DTI. Debt To Income ratio is actually more common in the residential property evaluation, like when you purchase your primary residence and the lender wants to see if you can pay them. It evaluates the borrower more than the property itself. Here is the formula:

DTI = Total Monthly Debt Payments / Total Monthly Gross Income

Notice the “debt payments” part is not just about the property, but it also needs to include other debts that you may have, including but not limited to: car payment, insurance premium, credit card minimum payment… etc. For typical residential loan underwriting, some guidelines require the DTI to be 45% or below, while other loan programs may allow DTI up to 50%. It is very rare to see loan programs that will lend to borrowers with DTI over 50%.

Knowing the various financial indicators and how to calculate them will only benefit your real estate investment adventure. Check out the book below.