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Rental Loans

**Last updated:** April 16, 2024

 

Use our **DSCR Calculator** to confirm your DSCR loan amount. Our DSCR loan calculator will help you screen rental property investment opportunities. Become an expert by understanding how things such as interest rate, rent, taxes, utilities, maintenance, property management and insurance affect DSCR.

 

In this article we will cover multiple ways and approaches that can be used to calculate DSCR ratio to quantify the attractiveness of a transaction. We will start at learning about the calculation itself and then move on to different variations of the calculation or the inputs that could be used. 

 

## DSCR Calculation

 

DSCR or **Debt Service Coverage Ratio** is a metric used by private lenders to assess the financial strength of a rental property and determine the maximum eligible loan amount or loan-to-value (LTV). When assessing the financial health and feasibility of a deal or investment, it's key to break down its capability to bring on sufficient cash flow to cover its debt liabilities. The Debt Service Coverage Ratio( DSCR) is a fundamental metric used by lenders, investors, and judges to assess the borrower's capacity to repay debt. In this blog post, we will dive into the concept of DSCR and provide a step-by-step companion on how to calculate it. 

 

The Debt Service Coverage Ratio (DSCR) is a financial benchmark that measures the relationship between the cash flow available to service debt and the debt payments due within a specific period. It's normally expressed as a ratio, which indicates the number of times the cash flow covers the debt arrears. 

 

Lenders frequently use DSCR as a crucial factor in determining the creditworthiness of a borrower, and investors count on it to estimate the risk associated with a deal. Below, you will learn how DSCR is calculated a few different ways that produce slightly different values. The simplest way to calculate DSCR is to divide Net Operating Income (NOI) by Principal and Interest (P&I). 

 

## DSCR Formula 

 DSCR is calculated using a simple formula: 
 
``` DSCR = Net Operating Income( NOI)/ Total Debt Service ```

 Let's break it down into its building blocks:

 

Net Operating Income( NOI) 

 

Net Operating Income represents the income generated by a property or investment after subtracting all operating costs but before subtracting interest, taxes, and non-operating costs. NOI can be calculated using the following formula 
 
 

NOI = Gross Revenue- Operating Expenses 

 
 
Gross Revenue includes the total income generated by the scheme, such as rental income, sales profit, or any other applicable sources. 

 

Operating Expenses include costs directly related to the operation and maintenance of the scheme, such as property taxes, insurance, repairs, utilities, and management fees. It doesn't include debt payments. 
 
 

 Total Debt Service 

 

Total Debt Service refers to the total volume of debt payments due within a specific period. It includes principal disbursements and interest payments on all outstanding debts. 
 
 

To sum it up, net Operating Income is Rent - Taxes - Insurance - Utilities - HOA - Property Management - Maintenance. A DSCR of 1 means the property generates just enough operating income to "service the debt" on the property. That means a DSCR of 1 is breakeven, $0 free cash flow. A DSCR greater than 1 means the rental property generates more than enough income to service its debt. A DSCR less than 1 means the property does not generate enough income to service its debt and therefore the owners need to pay out of pocket every month to cover the shortfall.

 

<table>
<thead>
 <tr>
 <th>DSCR</th>
 <th>Meaning</th>
 </tr>
</thead>
<tbody>
 <tr>
 <td>Less than 1</td>
 <td>Owner needs to pay out of pocket to cover monthly expenses</td>
 </tr>
 <tr>
 <td>1</td>
 <td>Owner breaks even, property covers its expenses exactly</td>
 </tr>
 <tr>
 <td>Greater than 1</td>
 <td>Owner receives excess cash, property more than covers expenses</td>
 </tr>
</tbody>
</table>

 

## DSCR Loan Calculation

 

In order to properly understand the concept of debt service coverage ratio, it's helpful to use an example:

 

Jenny is in contract to buy a rental property for $200,000. The property appraises for $200,000 with a $2,000 market rent opinion from the appraiser. Jenny's learns about a type of loan -- called a "DSCR loan" -- where the maximum loan amount is based on the cash flow of the property and she doesn't need to have a W2 or provide tax returns. The lender is able to provide up to 80% LTV ($160,000), as long as the debt service coverage ratio is at least 1.1 at 80% LTV. Jenny uses the calculator above to plug in the numbers and realizes that the property has a DSCR of 1.37 at 80% LTV, far more than the minimum required to qualify for 80% LTV.

 

Using the DSCR calculator not only helped Jenny understand what loan amount she qualified for, it gave her the confidence that she's buying a good deal, and it helped he understand the interplay between DSCR inputs including rent, taxes, insurance, and interest rates and how that affects cash to close and [cash on cash return](https://www.offermarket.us/real-estate-glossary/cash-on-cash-return). If the market rent were $1,500, Jenny would only qualify for 70% LTV because DSCR would be too low at higher LTVs.

 

## DSCR Loan Calculator

Lenders will have a minimum DSCR in their loan program guidelines, and if the DSCR is equal to or greater than that minimum, the property will qualify for [DSCR loans](https://www.offermarket.us/blog/dscr-loan-program) are business purpose loans that use the rental property as collateral, and are most commonly 30 year fixed rate mortgages. DSCR loan programs -- also known as non-QM or non qualifying mortgages -- do not look at the borrowers income or tax returns. 
 

DSCR loans are originated based on three core underwriting components:

 

1. Deal economics (DSCR) -- does the rental property generate cash flow?
2. Borrower credit score -- does the borrower have a history of paying their debts?
3. Borrower experience -- does the borrower have other investment properties and know what they're doing?

 

Borrower experience is less important because the borrower can always hire a property management company. Deal economics and credit score are deal breakers. Most rental property investors don't realize just how important their credit score, so read on on [how credit score affects your loan amount and interest rate for DSCR loans](https://www.offermarket.us/blog/how-credit-score-affects-ltv-for-dscr-rental-loans). Hint: 720 is the magic number!

 

See [DSCR Loan Interest Rate Index](https://www.offermarket.us/blog/dscr-loan-interest-rate-index).

 

## DSCR Calculation

 

Private lenders use two different formulas to calculate DSCR. It's important to understand each method in order to avoid max LTV surprises for your next DSCR loan.

 

## Max LTV for DSCR Loans

 

Many private lenders have a maximum LTV of 75% for cash out refinance, and 80% for purchases.

 

## DSCR for Vacant Rental Property

 

It is important to be aware that many lenders will utilize 90% of the appraised rent amount if your property is vacant at settlement. This will reduce your DSCR and may reduce the maximum LTV and loan amount.

 

## DSCR Method 1: NOI ÷ Debt Service

 

**NOI** = Rent - Taxes - Insurance - Utilities - HOA - Property Management - Maintenance

 

**Debt Service** = Mortgage Principal + Mortgage Interest

 

## DSCR Method 2: (Rent - Maintenance - Property Management - Utilities) ÷ PITIA

 

**PITIA** = Principal + Interest + Taxes + Insurance + Association Fees

 

## How to Calculate Debt Service Coverage Ratio (DSCR) for a Rental Property

 

Calculating DSCR for a rental property follow exactly the same steps as we outlined above. First you need to gather necessary data regarding the property as inputs to the calculation. Once you have the inputs and you need verify their accuracy by leveraging public data sources and finally calculate the DSCR itself. Below we will tackle this task step by step. 

 

### Input property-specific data

 

The data inputs for the calculation that need to be sourced from property data include: 

 

1. Rent
2. Taxes
3. Insurance
4. Utilities
5. HOA
6. Property Management
7. Maintenance
 
 

Once you have this data, if its for a new purchase, to look at comparable properties and see if your data is in the ballpark value of comparable properties. This will increase your confidence over the numbers that you are using since these are just estimates that you have research because you haven't actually received any rent or paid any bills for this property yet. 

 

Once you gained confidence into your input data we can proceed to the calculation step. Why is it important to verify your inputs versus comparable properties? Well, its important because if your inputs to the DSCR calculation are inaccurate, the conclusion of the calculation will also be inaccurate. In statistics there is a saying 'garbage in, garbage out', meaning, calculation is just a tool that depends on what information you provide it with. If you build a house on bad foundation, you will eventually have a bad house, same logic tracks for DSCR calculations and the input data they are based on. 

 

### Complete the DSCR calculation

 

First we must determine the Net Operating Income (NOI) as its the numerator of the DSCR ratio. Net Operating Income represents the income generated by the rental property after subtracting all operating expenses. To calculate the NOI, use the following formula: NOI = Gross Rental Income- Operating Expenses which can be expanded to:

```NOI = Rent - (Taxes + Insurance + Utilities + HOA + Property Management + Maintenance)```
 
Rent or Gross Rental Income, includes the total rental income generated by the property. It can be gained by multiplying the monthly rental rate by the number of occupied units and the number of months in a year. The second part of the formula is Operating Expenses. These are the costs associated with operating and maintaining the rental property. They include property taxes, insurance, repairs and maintenance, property management costs, utilities, and any other pointed charges. Exclude mortgage payments from the operating expenses. 


Now we are ready to determine the Total Debt Service. Total Debt Service refers to the total volume of mortgage payments due within a specific period. It includes both the principal and interest payments. You can find this information in your mortgage documents or by contacting your lender. Thus we must divide the Net Operating Income(NOI) by the Total Debt Service to calculate the Debt Service Coverage Ratio( DSCR) for your rental property. 

 
 
```DSCR = NOI/ Total Debt Service```

 

### Interpreting the DSCR 

 

 Once you have calculated the DSCR for your rental property, it's important to understand its implications 

 

 1. DSCR Value. 
 A DSCR value greater than 1 indicates that the rental property's cash flow is sufficient to cover its mortgage payments. The advanced the proportion, the more comfortably the property can handle its debt. 
 
 

 2. DSCR Threshold. 
 Lenders and investors may have different criteria for an acceptable DSCR. Generally, a DSCR of1.2 or advanced is considered favorable, as it provides a margin of safety. However, specific circumstances, such as the property's location or demand conditions, might need a advanced DSCR to mollify risks effectively. 
 
 

 3. Risk Assessment. 
 A low DSCR, below 1, suggests that the rental property's cash flow may not be enough to cover its mortgage payments. This indicates advanced threat for lenders and investors, as it increases the liability of financial difficulties in repaying the debt. 

 
 
As you can see, DSCR calculation for a rental property is almost identical to DSCR calculations for any other type of properties since inputs to the calculation remain the same.

 

## How to Calculate Debt Service Coverage Ratio (DSCR) from Cash Flow

 

While DSCR is typically calculated using Net Operating Income( NOI), it's also possible to calculate it directly from cash flow. In this blog post, we will guide you through the process of calculating the Debt Service Coverage Ratio( DSCR) using cash flow as a starting point. 

 

1. Determine Cash Flow Available for Debt Service - Identify the cash flow available to service debt within a specific period. This includes all available cash that can be allocated towards debt payments. Cash flow can be derived from sources such as operating income,non-operating income, and any other relevant inflows.
2. Determine Total Debt Service - Identify the total debt service, which includes all principal and interest payments due within the same period. This information can be obtained from loan documents or by contacting your lender. 
3. Apply the DSCR Formula - Divide the cash flow available for debt service by the total debt service to calculate the Debt Service Coverage Ratio( DSCR). 

 

## How to Calculate Debt Service Coverage Ratio (DSCR) in Excel

 

Knowing DSCR calculation and be able to use it is the first step to using it for your analysis of deals. The processionals, by virtue of needing to use this formula several times a day, have came up with easier ways to apply it to quickly gain insight into the characteristics of a deal. We are of course talking about implementing the DSCR calculation in Excel. 

 

Let's explore the step- by- step process of calculating the Debt Service Coverage rate( DSCR) in Excel 

 
 
1. Set Up Your Excel Worksheet - Open Excel and create a new worksheet. Label the columns as follows" Period,"" Cash Flow,"" Principal Payment," and" Interest Payment." 
2. Enter Cash Flow Data - In the" Period" column, enter the time ages for which you have cash flow data(e.g., months, quarters, or years). In the" Cash Flow" column, input the corresponding cash flow amounts for each period.
3. Enter Principal and Interest Payment Data - In the" Principal Payment" column, enter the principal payment amounts due for each period. In the" Interest Payment" column, enter the interest payment amounts due for each period. assure that the principal and interest payments align with the individual cash flow ages. 
4. Calculate Net Operating Income (NOI) - In a new cell, input the formula to calculate the Net Operating Income (NOI) using the following formula ```= SUM( Cash Flow)- SUM( Principal Payment)- SUM( Interest Payment)```
5. Calculate Total Debt Service - In a separate cell, input the formula to calculate the Total Debt Service using the following formula ```= SUM( Principal Payment) SUM( Interest Payment)```
6. Calculate DSCR - In another cell, input the formula to calculate the Debt Service Coverage Ratio( DSCR) using the following formula ```= Net Operating Income( NOI)/ Total Debt Service``` 

 

## How to Calculate Maximum Loan Amount Using Debt Service Coverage Ratio (DSCR)

 

If you know your DSCR as well as a ballpark interest rate your lender will charge you, you will be able to calculate the maximum DSCR loan you potentially qualify for. We say potentially because every lender is different and they might have internal rules that will limit loan amounts in certain situations depending on other factors that aren't captured in our calculation below. Given that, let's delve into the step- by- step process of calculating the maximum loan amount using the Debt Service Coverage Ratio (DSCR).
 
 
 
1. Determine the Net Operating Income (NOI) - Calculate the Net Operating Income (NOI) of the scheme. The NOI represents the income generated by the scheme after subtracting operating expenses but before accounting for debt payments. Use the following formula to calculate the NOI. NOI = Gross Revenue- Operating Expenses 
2. Determine the Desired DSCR Threshold - Establish the desired DSCR threshold based on lending standards, scheme threat, and other factors. For instance, lenders may require a minimal DSCR of 1.2 to mitigate threat effectively.
3. Calculate the Maximum Annual Debt Service( MADS) - Multiply the Net Operating Income( NOI) by the desired DSCR threshold to calculate the Maximum Annual Debt Service( MADS). The formula is as follows: MADS = NOI * DSCR Threshold 
4. Determine the Loan Amount - Divide the Maximum Annual Debt Service( MADS) by the estimated yearly interest rate to calculate the loan amount. Use the following formula: Loan Amount = MADS/ Annual Interest Rate 

 

Once we have the value in step 4, we need to interpreting it for the benefit of our analysis. Generally, the maximum DSCR loan amount has implication on three distinct but intra-related factors, loan affordability, risk and lender requirements. 
 
 
 
Loan Affordability - The maximum loan amount represents the estimated borrowing capacity based on the project's cash flow and the desired DSCR threshold. It provides an indication of the loan size that can be supported while maintaining a satisfactory DSCR. 
 
 

Risk Assessment - However, it's advisable to consider a lower loan amount to maintain a comfortable DSCR, If the calculated maximum loan amount exceeds the scheme's financing needs. This mitigates the threat of financial strain in case of unexpected changes in the scheme's cash flow. 
 
 

Lender Requirements - Keep in mind that lenders may have specific criteria regarding DSCR and loan- to- value ratios. They may impose additional requirements based on the scheme's characteristics, such as its location, market conditions, and industry risks. 

 
 
Calculating the maximum loan amount using the Debt Service Coverage Ratio( DSCR) is a critical step in assessing the borrowing capacity of a deal. By considering the deal's cash flow, desired DSCR threshold, and estimated annual interest rate, you can determine the maximum loan amount that can be reasonably supported. Remember to factor in threat considerations and lender requirements when determining the optimal loan amount for your specific deal.

Use our DSCR Calculator to see how much of a DSCR loan you qualify for! Run your rental property purchase and refi scenario through our DSCR loan calculator.

DSCR Calculator

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