Debt Service Coverage Ratio (DSCR) otherwise known as the debt coverage ratio (DCR) is one of the main tools that lenders use when deciding whether to make a particular loan.
A simple example of how DSCR is calculated is as follows:
= Earnings before Depreciation, Interest / Taxes
Total Debt Service
A ratio that is above 1/1 would show that the borrower has excess income to meet continuing obligations plus the payments any loan that the lender is contemplating giving. A ratio below 1/1 would mean that there is not enough income to support the proposed debt along with existing obligations.
The vast majority of lenders describe themselves as cash flow lenders. This would include pretty much all banks, credit unions, life Insurance companies, etc. In order to get a loan from a cash flow lender a ratio in excess of one is normally required.
Most borrowers who find themselves with a DSCR below one, end up with a private money loan. This is often called "Hard Money,” and rightfully so as the rates and fees are significantly above that of traditional lenders.
Different banks have different DSCR requirements and depending upon the specifics of any transaction the required DSCR could be higher or slightly lower. Generally speaking, those lenders that offer the lowest rates would like to see a higher DSCR. Not always, but in general the lower the rate the more stringent the cash flow requirement. It is a reasonable assumption that most national banks look for a DSCR approximating 1.25/1 or higher.
Occasionally, a SBA lender will consider a loan to a borrower who has existing financials that show a DSCR below 1/1 if the borrower has a reasonable projection showing the ability to make the loan payments. An example of this would be a business that purchases a property to expand their existing facility. The projected income to pay the loan will come from the efficiency of the new location and would not be reflected in historical financials.
Why this is important
The debt service coverage ratio impacts a borrower's ability to get a loan at reasonable rates and terms. Private money loan rates can be at least three percent higher than conventional rates and usually significantly more.
What you can do about it
When looking at the above ratio for DSCR, the denominator (part that is below the line) consists of total debt service. The smaller that number is - the greater the loan that you will qualify for from a cash flow lender.
Simple example of how this would affect your ability to get a loan
Let's say a major bank is looking at making a loan on your property at about a 6% annual interest rate for a thirty year term.
You have $15,000 is credit card debt and you just leased a nice car with a $550 monthly payment.
A lender could assume a monthly cost to you for the credit card debt to be $450 per month and with the $550 lease payments you have $1,000 monthly expenses.
If you waited to lease the new car and used your excess money to pay off your credit card debt you would qualify for an extra $150,000 in financing.
If you have any questions regarding commercial real estate loans please give me a call. I am actively working on conventional commercial real estate loans and SBA loans. I have over a quarter century of experience and would be pleased to see how I could help.
Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing.
Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com
A simple example of how DSCR is calculated is as follows:
= Earnings before Depreciation, Interest / Taxes
Total Debt Service
A ratio that is above 1/1 would show that the borrower has excess income to meet continuing obligations plus the payments any loan that the lender is contemplating giving. A ratio below 1/1 would mean that there is not enough income to support the proposed debt along with existing obligations.
The vast majority of lenders describe themselves as cash flow lenders. This would include pretty much all banks, credit unions, life Insurance companies, etc. In order to get a loan from a cash flow lender a ratio in excess of one is normally required.
Most borrowers who find themselves with a DSCR below one, end up with a private money loan. This is often called "Hard Money,” and rightfully so as the rates and fees are significantly above that of traditional lenders.
Different banks have different DSCR requirements and depending upon the specifics of any transaction the required DSCR could be higher or slightly lower. Generally speaking, those lenders that offer the lowest rates would like to see a higher DSCR. Not always, but in general the lower the rate the more stringent the cash flow requirement. It is a reasonable assumption that most national banks look for a DSCR approximating 1.25/1 or higher.
Occasionally, a SBA lender will consider a loan to a borrower who has existing financials that show a DSCR below 1/1 if the borrower has a reasonable projection showing the ability to make the loan payments. An example of this would be a business that purchases a property to expand their existing facility. The projected income to pay the loan will come from the efficiency of the new location and would not be reflected in historical financials.
Why this is important
The debt service coverage ratio impacts a borrower's ability to get a loan at reasonable rates and terms. Private money loan rates can be at least three percent higher than conventional rates and usually significantly more.
What you can do about it
When looking at the above ratio for DSCR, the denominator (part that is below the line) consists of total debt service. The smaller that number is - the greater the loan that you will qualify for from a cash flow lender.
- Prior to applying for a loan, pay off all your credit cards. Banks often take a percentage of your total balance and apply it to your total debt service. This amount varies from lender to lender, but can be from three percent to five percent of your outstanding balance. For example, if you owe $10,000 in credit card debt, a lender would assume $300 to $500 in monthly payments.
- Buy or refinance your commercial real estate before you make any purchases that require monthly payments. Every dollar in monthly payments that a borrower has is added to the denominator.
- To the vast majority of lenders the most important year for the DSCR is the last year for which they have tax returns or audited financial statements. So if you are planning to purchase or refinance commercial real estate in 2014, you want your 2013 taxes to look good.
Simple example of how this would affect your ability to get a loan
Let's say a major bank is looking at making a loan on your property at about a 6% annual interest rate for a thirty year term.
You have $15,000 is credit card debt and you just leased a nice car with a $550 monthly payment.
A lender could assume a monthly cost to you for the credit card debt to be $450 per month and with the $550 lease payments you have $1,000 monthly expenses.
If you waited to lease the new car and used your excess money to pay off your credit card debt you would qualify for an extra $150,000 in financing.
If you have any questions regarding commercial real estate loans please give me a call. I am actively working on conventional commercial real estate loans and SBA loans. I have over a quarter century of experience and would be pleased to see how I could help.
Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing.
Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com
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