Understanding the DSCR Formula: A Guide for Real Estate Investors
When diving into real estate investment, understanding how lenders evaluate potential properties is crucial. One key metric that plays a significant role in this evaluation process is the Debt Service Coverage Ratio (DSCR). This guide will break down the DSCR formula, providing the knowledge you need to ensure your future investments qualify before committing time and resources to inspections and appraisals.
What is the DSCR Formula?
The DSCR formula is a tool that lenders use to measure a property's ability to cover its debt obligations. For residential properties ranging from one to four units, the formula is simple: the monthly rent is divided by the P.I.T.I.A. (Principal, Interest, Taxes, Insurance, and Association dues, if applicable). For properties with more than four units, a slightly different commercial formula is used.
Breaking Down P.I.T.I.A.
P.I.T.I.A. encompasses all key payments associated with holding a property:
Principal and Interest: These are the main components of your mortgage payment.
Taxes: Property taxes based on the value of the property.
Insurance: Homeowners insurance premiums protecting the property.
Association Dues: Applicable for properties within community associations.
If a property does not have association dues, simply omit that component from the calculation.
Example DSCR Calculation
Consider an example where the monthly rent is $1,750 and the housing payment is $1,650. By dividing these numbers, the result is a DSCR ratio of 1.06. Generally, lenders look for a DSCR ratio of 1:1 or greater, indicating that the property generates enough income to cover its debt obligations.
Interest-Only DSCR Loans
For properties with a DSCR slightly below one, some lenders offer interest-only DSCR loans, where the principal isn't factored into the ratio. This option might be suitable under certain circumstances.
Minimum DSCR Requirements Vary by Lender
Each lender may have different DSCR requirements. Some accept a "no ratio" approach, where rental income isn't a factor, typically demanding a larger down payment or a lower loan-to-value ratio on refinancing due to increased risk. Others might have a minimum ratio between 0.75 and 0.99, but the most favorable loan rates generally require a ratio of at least 1:1.
DSCR Calculator
Ready to see if your property meets DSCR requirements? Click here to get your free DSCR calculation and loan options — or schedule a quick call to review your numbers with a licensed mortgage expert.
