What DSCR measures and why lenders prefer it
DSCR compares the cash a business or property throws off in a year with everything it owes its lenders in the same year. Above 1.00× there is cash left after the loan payments; below 1.00× the payments have to come from somewhere else. Commercial banks, SBA lenders, agency multifamily lenders and equipment financiers all size loans off this one ratio.
Its advantage over an earnings-based coverage test is that the denominator contains principal. A borrower can look comfortable on interest coverage at 5× and still fail DSCR badly, because interest is only part of what has to be paid. Principal is not tax-deductible, cannot be reduced by a rate cut, and in a stressed credit market cannot be assumed away by refinancing. It is the obligation that actually causes defaults.
The other reason lenders like it is that it is a cash test, not an accruals test. Done properly the numerator is not accounting profit at all: it starts from EBITDA or net operating income and then strips out the cash the business has no choice about spending — taxes it actually pays, the maintenance capital spending that keeps the trucks running, and any distribution the owners will keep taking. What is left is genuinely available to service debt, which is why the number is called cash available for debt service.
Building the two halves of the ratio without cheating
Almost every DSCR argument is about the numerator. The denominator is arithmetic; the numerator is judgement.
Start from EBITDA or NOI. For an operating company, EBITDA is the conventional starting point because depreciation is non-cash and interest is what you are testing. For income property, the equivalent is net operating income — rent less vacancy, operating expenses, management fees and a replacement reserve, but before any mortgage payment. Never start from net income: it is already net of the interest you are trying to cover.
Then deduct the cash you do not control. Three deductions separate a real credit analysis from a marketing calculation. Cash taxes, because the tax authority is paid before the bank. Unfunded capital expenditure — the replacement spending funded out of operating cash rather than from a new loan — because a business that stops replacing assets stops producing EBITDA. And owner distributions where they are not genuinely discretionary; in a closely held company the owner's draw is often the family's living cost and will not stop.
Build the denominator from the amortisation schedules. Add next year's scheduled principal, next year's cash interest, and finance lease payments if the lender treats them as debt. Include the current portion of long-term debt, capitalised equipment leases, and any balloon falling due inside the test period — a bullet maturity inside twelve months can turn a 1.4× ratio into 0.3× overnight. Exclude optional prepayments and revolver fluctuations that reverse within the year.
Then run it backwards. That is the calculation lenders actually perform. Divide cash available for debt service by the target ratio and you get the maximum annual payment they will approve. Convert that payment into a loan balance using the debt service constant — annual debt service per dollar of loan, which depends only on the rate and the amortisation period — and you have the loan size. This is why two lenders quoting the same rate can offer very different amounts. How much different depends on the rate: in the table below, $80,000 of annual debt service supports $742,000 over 15 years and $943,000 over 25 years at 7% — 27% more — while at 5% the same stretch is worth 35% more ($843,000 against $1,140,000). The lower the rate, the more a longer amortisation buys you.
Worked example: a $900,000 EBITDA business asking for more debt
A distribution company reports EBITDA of $900,000. It pays $90,000 of cash tax and spends $60,000 a year replacing forklifts and racking out of operating cash. Existing debt costs $200,000 of interest and amortises at $300,000 a year. Its bank tests DSCR at 1.25× and is quoting 7.5% over a 10-year amortisation.
- Cash available for debt service. $900,000 − $90,000 − $60,000 − $0 = $750,000.
- Total debt service. $300,000 principal + $200,000 interest = $500,000.
- DSCR. $750,000 ÷ $500,000 = 1.50×. The covenant is met.
- Surplus. $750,000 − $500,000 = $250,000 of cash left after the bank is paid.
- Maximum debt service at 1.25×. $750,000 ÷ 1.25 = $600,000 a year, or $50,000 a month.
- Convert to a loan. At 7.5% over 120 months the monthly rate is 0.075 ÷ 12 = 0.00625 and (1.00625)−120 = 0.473466. The annuity factor is (1 − 0.473466) ÷ 0.00625 = 84.2455. So $50,000 × 84.2455 = $4,212,000 of total supportable debt.
- Cushion. 1 − (1.25 × $500,000 ÷ $750,000) = 1 − 0.8333 = 16.7%. Cash flow can fall by a sixth before the covenant binds.
The last two figures are the ones to argue with. The $4,212,000 is total debt, not new debt: existing borrowings already consume $500,000 of the $600,000 allowance, so the genuine new-money capacity is small. And stretching the amortisation to 20 years raises the supportable total to about $6,207,000 at the same rate and the same payment — which is exactly how a borrower with a tight DSCR gets a larger loan, at the cost of paying interest for twice as long.
How to read the result: the levels lenders actually use
1.25× is the working convention for commercial term debt and stabilised income property, and most credit policies sit in a 1.20× to 1.35× band. SBA underwriting under SOP 50 10 has generally been comfortable at a lower threshold, around 1.15×, because the guarantee absorbs part of the risk. Construction, hospitality and single-tenant credits are usually held to a higher minimum than stabilised property, because the cash flow is less predictable — the term sheet will say by how much.
Below 1.00× is not a weak ratio, it is a funding gap: the asset does not pay for itself and something else must. 1.00× to 1.15× leaves almost no margin, so a single bad quarter can turn into a missed payment. 1.25× to 1.50× is comfortable for most borrowers. Above 2.00× the debt is barely a constraint, and the question flips to whether the balance sheet is under-levered — cheap debt left unused is expensive equity.
Read two other things alongside the level. The cushion tells you how far cash flow can fall before the test fails, which is far more informative than the ratio itself: 1.35× on volatile earnings is riskier than 1.20× on contracted rent. And the trend in the denominator matters, because debt service is not constant. A loan with a balloon, an interest-only period ending, or a floating rate that resets will change the denominator without any change in trading, and it is almost always the denominator that breaks the covenant first.
Finally, be clear about which DSCR you are quoting. A global DSCR adds the guarantor's personal income and personal debt service to both halves, which is the standard test for closely held businesses. A property-level DSCR looks only at one asset. The same borrower can pass one and fail the other.
Loan supported by $100,000 of net operating income at a 1.25× DSCR
| Amortisation | 5.0% | 6.0% | 7.0% | 8.0% | 9.0% |
|---|---|---|---|---|---|
| 15 years | $843,000 | $790,000 | $742,000 | $698,000 | $657,000 |
| 20 years | $1,010,000 | $931,000 | $860,000 | $797,000 | $741,000 |
| 25 years | $1,140,000 | $1,035,000 | $943,000 | $864,000 | $794,000 |
| 30 years | $1,242,000 | $1,112,000 | $1,002,000 | $909,000 | $829,000 |
Scale linearly with NOI: $250,000 of NOI at 7% over 25 years supports 2.5 × $943,000 = about $2,358,000. Values are the present value of a monthly annuity, rounded to the nearest thousand.
A "DSCR loan" is a product, not a different formula
Lenders now market DSCR loans for rental property: instead of verifying the borrower's personal income, they qualify the loan on the property's own coverage, typically requiring 1.00× to 1.25× on market rent net of taxes, insurance and HOA. The arithmetic is identical to what this calculator does — the difference is only which cash flow the lender agrees to look at. Read the term sheet carefully for what it puts in the numerator: some programmes use gross rent rather than net operating income, which produces a far more flattering ratio and a much larger loan.
Mistakes that inflate a DSCR
- Leaving principal out of the denominator. Then you have computed interest coverage. It is the single most common error, and it overstates capacity badly on short amortisations.
- Starting from net income. It is already net of interest and tax. Start from EBITDA or NOI.
- Ignoring maintenance capital spending. A haulage business with no truck replacement budget shows a fine DSCR right up to the year the fleet has to be replaced, and then shows a very bad one.
- Using gross rent instead of net operating income. The overstatement is exactly the reciprocal of your expense ratio: if operating expenses consume 40% of gross rent, coverage computed on gross rent is 1 ÷ 0.60 = 1.67 times the true figure.
- Missing a balloon inside the test period. Any maturity falling due within twelve months belongs in debt service, and it will dominate the ratio.
- Forgetting owner draws in a pass-through entity. If the company pays no tax because the owner does, the owner's distribution is not optional and the lender will deduct it.
- Annualising a strong quarter. Lenders test trailing twelve months, and they will ask for the seasonal trough.
- Quoting a property DSCR when the lender wants a global one. Global DSCR includes the guarantor's personal debt service, which usually lowers the ratio.
Where DSCR sits among the other credit tests
DSCR is the flow test that decides whether a loan gets made and at what size. It is normally paired with a stock test and a liquidity test, and the three answer different questions.
Debt to EBITDA asks how many years of earnings the debt represents — the stock question. It is insensitive to amortisation, so a borrower at 3.0× leverage may have a comfortable or a punishing DSCR depending purely on how fast the loan repays. Most credit agreements carry both, and the tighter of the two is what actually governs. Interest coverage is the same flow test with principal removed, which makes it the right ratio for bond issuers whose debt is not amortising at all.
On the balance sheet, debt to total assets and debt to equity describe how the business is financed rather than whether it can pay. For liquidity, the current ratio tells you whether the next twelve months of obligations are covered by current assets. And because the whole ratio depends on the quality of the cash flow figure you feed it, cross-check the numerator against free cash flow before you rely on it in a credit paper.
Key terms
- Cash available for debt service (CADS)
- EBITDA or net operating income less cash taxes, unfunded maintenance capital spending and non-discretionary owner distributions. Sometimes called net operating income available for debt service.
- Debt service
- All principal, interest and lender-recognised lease payments contractually due in the test period, including the current portion of long-term debt and any balloon falling due.
- Debt service constant
- Annual debt service per dollar of loan at a given rate and amortisation, also called the mortgage constant. Multiply a loan by it to get the payment; divide a payment by it to size a loan.
- Global DSCR
- A coverage test that combines business cash flow with the guarantor's personal income, and business debt service with the guarantor's personal debt service. Standard for closely held borrowers.
- Amortisation period
- The schedule the payment is calculated over, which can be longer than the loan term. A 25-year amortisation with a 10-year maturity produces a balloon.