What is a Debt Covenant Ratio?

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Real estate investors need to calculate the Debt Covenant Ratio prior to investing in rental property.
Real estate investors need to calculate the Debt Covenant Ratio prior to investing in rental property. (Image: Real Estate image by Stephen VanHorn from Fotolia.com)

Owning rental property can be a gold mine for real estate investors. However, if an investor seeks to get a loan on a property and the projected Debt Covenant Ratio is not adequate, the bank will not lend money to that real estate investor.

Debt Covenent Ratio (DCR)

Debt Covenent Ratio (DCR) applies to real estate investors who purchase property with the intent of renting it and generating a rental income. DCR is the ratio the banks or lenders use to determine whether to grant the real estate investor the loan required to purchase the property.

How it works

Banks calculate the DCR by dividing the property's annual net rental income from the total annual debt service or loan payments. According to RentalSoftware.com, the bank will not lend if the DCR is less than 1.

Example

If your net annual rental income is $30,000 and your annual debt service or loan payments is $22,000, then the DCR is 1.5 ($30,000/$20,000). However, if your annual debt service is $32,000, your DCR will be 0.93 and the bank will not lead with a DCR at 0.93.

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