Debt Coverage Ratio (DCR)

Debt Coverage Ratio is a term real estate investors and real estate agents involved with real estate investing have probably heard of but might not understand.

Debt Coverage Ratio (DCR) is a ratio that provides lenders information on the extent to which the income property's net operating income (NOI) covers debt service and is useful to the lender's decision making with regard to financing or refinancing an investment. Simply stated, it helps mortgage lenders determine whether the rental property generates enough cash to cover its mortgage payment.

How to Calculate

Debt Coverage Ratio = Net Operating Income / Debt Service

EXAMPLE ONE: Let's assume a borrower is requesting a mortgage with annual payments of $40,000 on an real estate investment property that generates a net operating income of $50,000. The DCR computes at 1.25 ($50,000 / 40,000 = 1.25).

EXAMPLE TWO: Now let's assume a mortgage with annual payments of $50,000 on the same net operating income of $50,000. The DCR computes at 1.00 ($50,000 / 50,000 = 1.00).

EXAMPLE THREE: Lastly, let's assume a mortgage with annual payments of $55,500 on the same net operating income of $50,000. The DCR computes at 0.90 ($50,000 / 55,500 = 0.90).

How to Apply

EXAMPLE ONE (1.25 DCR): This tells the lender that there are more than enough funds to cover the debt service. Let's check it: $50,000 (funds available) less 40,000 (mortgage payment) = 10,000. That is, not only are there enough dollars provided to cover the mortgage payment, there are 10,000 more dollars (25% more) than the payment requires. This is a good thing.

EXAMPLE TWO (1.00 DCR): This tells the lender that there are just enough funds to cover the debt service. Same procedure: $50,000 (funds available) less 50,000 (mortgage payment) = 0. That is, there are enough dollars provided to cover the mortgage payment, but nothing would be left over for any margin of error. This is typically not good enough.

EXAMPLE THREE (0.90 DCR): This tells the lender that there are not enough funds to cover the debt service. Once more: $50,000 (funds available) less 55,500 (mortgage payment) = -4,500. That is, there are not enough dollars provided to cover the mortgage payment and would require the owner to make up the difference "out-of-pocket." This is absolutely not good enough.

As a quick point of reference just remember that 1.0 is break-even, any ratio that's higher means more than enough to cover the mortgage payment, and any ratio that's lower means less than enough to cover the mortgage payment. Naturally what ratio a lender is willing to accept is up to the lender, but don't be surprised to find that most look for a DCR of at least 1.20.

ProAPOD® Real Estate Investment Software computes debt coverage ratio in real time as you enter the property and mortgage data for any rental income property, of any size. The DCR is recalculated each time you make changes so it is always accurate. Reports such as the APOD, proforma income statement, marketing package and assumptions include DCR.

So You Know

ProAPOD® Real Estate Investment Software computes the debt coverage ratio automatically as you enter the property data. It is recalculated in real time each time you make changes to the data so it is always accurate. LEARN MORE