Your debt service coverage ratio is calculated by dividing your net operating income (NOI) by your total debt service. The formula looks like this: DSCR = Net Operating Income / Total Debt Service If your DSCR is lower than 1.0, this indicates you don’t have enough income to cover your mortgage payments. If your DSCR is exactly 1.0, it would indicate you make exactly enough to make your mortgage payments and nothing more. If your DSCR is higher than 1.0, it would indicate you can cover your loan payments with cash left over.
The higher your DSCR, the healthier it is, and the more successful you’ll likely be with your loan. Lenders may have different minimum DSCR requirements, but you can expect a lender to set a minimum DSCR around 1.1 –1.25.
As you can see in the equation above, you’ll need to know a few other numbers – your Net Operating Income and your total debt service.
Net Operating Income
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, this would just be your yearly gross income (what you make before taxes are taken out). You wouldn’t need to subtract any operating expenses. For home buyers without a business, NOI = Annual Gross Income.
To get your yearly gross income, add up your salary, any freelance income, rent collected, legal judgments awarded, royalties and any other income.
Total Debt Service
Next, you’ll figure out your total debt service, which is the total amount of debt you pay each year. To calculate your total debt service, you’ll add up your estimated new monthly mortgage payment (including property taxes and homeowners insurance, if you know those costs) credit card bills, auto loans, student loans and any other monthly payment and multiply by 12.
Total Debt Service = Total Monthly Debts x 12
If you’re calculating on behalf of a business, keep in mind that businesses take on a wider range of debts each year. Their total debt service would include the cash flow needed to cover salaries, business taxes and other operating expenses.
Once you have your NOI (or annual gross income) and your total debt service (your total annual debt), you can calculate your own annual DSCR.
Here’s a real estate example for a home buyer who doesn’t own a business.
