Lenders use the debt service coverage ratio (DSCR) to measure the ability of a borrower to repay on a loan. In personal finance, it is most commonly used to determine the loan amount for income-based loans. A ratio of 1 means that the net income of an individual is enough to pay for 100% of the value of the loan. Generally, lenders prefer a ratio over 1.
Define your property variables. Let's say you would like to buy a commercial property worth $500,000. The gross rent from the property yields $250,000 annually, and average vacancies are 10 percent or $25,000. All other maintenance expenses are $25,000.
Define loan variables. You are requesting a $1,000,000 loan over the next five years at a rate of 10 percent. The annual payment is $100,000.
Calculate net income. Gross income equals gross rent ($250,000) minus average vacancies ($25,000) minus all other expenses ($25,000). The net income is $200,000.
Calculate the debt service ratio. Divide net income ($200,000) by the loan payment ($100,000). The answer is 2.
Analyze the ratio. The income generated from the property is 2 times the amount of the loan repayment.