# Debt Service Coverage Ratio

The debt service coverage ratio, or the debt coverage ratio, is one method lenders will use to determine if a borrower should receive a loan. The ratio compares cash flows to the interest and principal payments required to pay off a loan. The ratio helps the lender assess if the borrower can cover the debt payments with the available cash flows.

This ratio is very common when purchasing real estate. However, loans for non-real estate purposes may also be subject to a specific debt service coverage ratio. If you are an individual purchasing a new vehicle, for example, the bank will want to ensure you can make the loan payments. An individual or business looking to purchase another business using an SBA loan will also need to meet a specific ratio.

### Calculation

Use the following formula to calculate the debt coverage ratio:

Debt Coverage Ratio = Net Operating Income / Debt Service

where:

Net Operating Income ("NOI") = Revenue + Depreciation + Interest Payments + Other Non-Cash Items

Debt Service = Principal payments + Interest payments + Lease payments

Many lenders require a debt service coverage ratio of 1.2 or higher.

A ratio under 1 indicates that the cash flows generate by the property are not sufficient to cover the debt service payments. For example, a ratio of 0.75 indicates that the property only generates enough cash flow to cover 75% of the debt service.

A ratio of more than 1 indicates that the property generates enough cash flow to cover the debt service and then some. For example, a ratio of 1.2 indicates that the cash flows can cover the principal, interest, and lease payments and generate 20% more income than is necessary to pay the bills.

Essentially, if you are seeking a loan the higher the debt service coverage ratio, the better your odds of receiving the loan.