DSCR: What it is and how to calculate it

Your ability to qualify for a mortgage depends on certain financial factors, including your income, assets, credit history, and total debt. Before a lender will approve you for a home loan, they need to make sure your other debt obligations won’t prevent you from keeping up with your mortgage payments.

Debt service coverage ratio (DSCR) is a figure lenders use to measure a borrower’s ability to cover all of their debts. DSCR can be a useful tool that helps individuals and businesses evaluate their ability to qualify for and keep up with a mortgage. Let’s take a closer look at what DSCR is and how you can calculate it.

What is debt service?

Your total debt service is the amount of money you need to fully repay your debt obligations. Servicing debt means making the required principal and interest payment on your mortgage and covering the minimum required payments on your other debts. The principal is the amount you borrowed and have to pay back, while the interest is what the lender charges you to borrow the money.

To calculate your total debt service, you’ll add up your estimated new monthly mortgage payment, including property taxes and homeowners insurance, along with the minimum monthly payment required for credit card bills, auto loans, student loans, and any other monthly payments. Then, you take this sum and multiply it by 12.

Total Debt Service = Total Monthly Debts x 12

Taking on more debt means you’ll have to spend a greater percentage of your gross annual income on paying it off. If you want to borrow money, it’s best to have a lower total debt service. This shows lenders your other debts likely won’t interfere with your ability to make your mortgage payments on time.

Debt service coverage and real estate

Debt service coverage comes into play when lenders gauge your ability to qualify for a loan. Calculating how much debt a borrower has to cover relative to their income can help a lender determine whether that borrower can afford to repay the mortgage.

If a borrower’s debts already consume too much of their gross monthly income, lenders will be more hesitant to approve them for a mortgage. If a borrower doesn’t have much debt or has an income that can easily cover the debt they do have, they will be more likely to get approved.

Debt service is used for a variety of different types of real estate transactions, including home buying, commercial real estate, small business lender, and project financing.

What is the debt service coverage ratio (DSCR)?

Debt service coverage ratio (DSCR) measures how much of your gross annual income is consumed by your mortgage debt. For a home buyer, your gross monthly income is the amount you make each year before taxes are taken out, and your mortgage debt is your monthly mortgage payment. For a business or real estate investor, DSCR reflects how much of the revenue generated by the property must go toward paying off the loan used to purchase it.

Lenders will consider you more of a risk to miss your mortgage payments if you’re spending too much of your income on housing costs. If you’re spending 50% of your income on housing, you're far more at risk of missing payments than if you’re spending just 20% on these costs.

Having a higher DSCR indicates to lenders that you can comfortably afford your debt payments and you’re likely to get approved for a mortgage. Having a low DSCR means your debt consumes a high percentage of your income and could jeopardize your eligibility.  If you are approved for a mortgage with a lower DSCR, you can expect to be charged a higher interest rate.

DSCR is similar to another figure known as debt-to-income ratio (DTI). Both figures are used by lenders to see how much of your income is consumed by debts. However, DTI is calculated by adding up all your various debts and dividing it by your gross monthly income. DSCR is calculated by taking your annual net operating income and dividing it by your monthly mortgage payment.

Nuances to be aware of when calculating DSCR

There are certain factors that can include your DSCR:

• Making continued mortgage rates can increase your DSCR over time, especially if your income or the income generated by the property isn’t consistent.
• Nonrecurring, one-time expenses like unexpected maintenance are typically excluded from DSCR calculation but can affect your debt and ability to keep up with mortgage payments.
• DSCR does not factor in potential vacancies that will affect your net operating income  

How to calculate your debt service coverage ratio

Your debt service coverage ratio is calculated by dividing your net operating income (NOI) by your total debt service. Here’s the formula:

DSCR = Net Operating Income / Total Debt Service

Net operating income is frequently used in business and real estate investing. It helps find the total amount of income a business or investor would make after expenses are taken out. For businesses, the equation would be:

NOI = (Gross Operating Income + Other Income) - Operating Expenses

For those who don’t own a business, your NOI would just be your yearly gross income, which is what you make each year before taxes are taken out. You wouldn’t need to subtract any operating expenses.

DSCR example

Here’s how to calculate DSCR if you’re a home buyer who doesn’t own a business:

• Monthly mortgage payment: $2,200
• Credit card #1 minimum payment: $100
• Credit card #2 minimum payment: $80
• Monthly car payment: $300
• Monthly student loan payment: $100

Total monthly debt = $2,780

Total Monthly Debts x 12 = Total Debt Service

$2,780 x 12 = $33,360

Then, suppose your annual gross income (and NOI) is $100,000.

DSCR = Net Operating Income / Total Debt Service

DSCR = $100,000 / $33,360

DSCR = 2.997

With a DSCR of just under 3.0, this indicates that you have enough income to cover your debts.

FAQ about DSCR 

Here are the answers to some frequently asked questions about DSCR and debt service.

Is total debt service the same as total debt?

Yes, total debt service represents the total amount of debt you have on a monthly or yearly basis.

How is DSCR different from DTI?

DSCR and DTI are both figures that represent your debt obligations compared to your total income. However, DTI is typically used for home buyers, while DSCR is more commonly used for businesses and real estate investors. They also have different formulas. DSCR is calculated by taking your net operating income and dividing it by your total debt service, while DTI is calculated by taking your monthly debt payment and dividing it by your gross monthly income.

How often should I recalculate DSCR?

It can be helpful to recalculate your DSCR if you’ve had any changes to your income or debts. For example, if you’ve paid off a credit card or car loan, this could increase your DSCR. On the other hand, if you’ve taken on new debt or your income has been reduced, you can expect your DSCR to drop.

What does 1.25 debt service coverage mean?

If your debt service coverage ratio is 1.25, or 125%, that means your net operating income is 125% of your debt obligations. In other words, you can pay all your debts, with additional cash left over. 

Why is my DSCR negative?

Your DSCR can be negative if your net operating income is less than your total debt and your business is losing money. You typically cannot get approved for a loan with a negative DSCR.

The bottom line: Understanding debt servicing can help you make critical decisions

Debt service is the amount of money you need to pay your debt obligations. Debt service coverage ratio (DSCR) is a figure that reflects how much of your annual income is consumed by debt. DSCR is one figure that lenders use to determine an individual or business’ eligibility for a loan. A higher DSCR indicates that you have plenty of income to cover your debts, while a lower DSCR shows that much of your income is consumed by debt. Each lender has their own DSCR requirements, but you’ll typically need a DSCR of at least 1 to get a mortgage.

You can use our Home Affordability Calculator to see what you can afford based on your income and debt. If you’re feeling good about your finances and are ready to apply for a mortgage, you can start the process with Rocket Mortgage today.

¹Refinancing may increase finance charges over the life of the loan.

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