Debt service coverage ratio.
In plain English
The debt service coverage ratio compares the cash a business generates to everything it must pay lenders in a period, principal and interest together. A ratio of 1.0 means income exactly covers the payments with nothing spare. Below 1.0 the borrower is dipping into reserves or new borrowing to stay current. Commercial real estate lenders and small-business lenders lean on this ratio heavily and often require a minimum well above 1.0 before approving a loan. Definitions of the cash figure differ by lender, so the same property can produce different ratios in different underwriting files.
01Why it matters
It is the test a lender actually applies, so it tells you whether a business or a property can carry its own loan out of what it earns rather than out of the owner's pocket.
02The math, step by step
A rental property produces $180,000 of net operating income a year. The mortgage costs $150,000 a year in principal and interest. $180,000 divided by $150,000 is a coverage ratio of 1.2, leaving $30,000 of cushion.
Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.
03What this is NOT
Interest coverage counts only the interest portion of the bill. Debt service coverage adds required principal repayments, which are usually the bigger number on an amortizing loan. The broader measure is always the tougher test.
04Receipts
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Plain-English answers from our glossary. Receipts included. Never advice.
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