Conventional Mortgage Alternative: Debt-Service Coverage Ratio (DSCR)

Here at A Nightmare on Loan Street Blog, we delve deep into the realm of alternative lending.  That can mean looking at conventional loans, then taking a hard right turn.  Or left.  The point is that we can help you learn about a different direction for your mortgage.  

You buddy Phil is writing this post about something called Debt-Service Coverage Ratio, or DSCR.   I want to help you feel less intimidated about what some would consider a big, scary term.  Also, 4-letter acronyms are intense.  Can you think of another off the top of your head?  All I could think of was YOLO, and then I threw up in my mouth a little bit because of how easily that came to me.  Anyway, let’s examine the DSCR a little closer.

The DSCR is a way for lenders to measure a person or company’s available cash flow to pay debt.  In terms of getting a mortgage, it’s a way for a lender to see if you’re able to repay your loan when a W2 or tax return doesn’t tell your financial story.  

The most basic way to see a Debt-Service Coverage Ratio is using the equation below:

  Your Net Revenue

DSCR = —————————

Any Debt You Have

*Your Net Revenue = Annual Net Operating Revenue minus Operating Expenses

*Any Debt You Have = Debt obligations you have for the year (interest, principal, lease payments, etc…)

Usually, lenders will be looking for a score north of 1.  Otherwise, it means that the revenue you generate won’t cover the debt. 

I usually find it easiest to work in practical examples.  Let’s think about someone who wrote to the Blog recently named Lisa.  Lisa is in real estate and loves to develop killer houses with a goal of generating rental income.  Lisa doesn’t pay herself a ton on her W2, and she invests a lot of her money into her next project.  This can make it difficult to get a mortgage from a big bank.  

Lisa brings in about $2,000,000 in net revenue each year, and has debt of $500,000.  If we plug Lisa’s net revenue and debts for the year into the equation above, it would look like this:

  $2,000,000 DSCR = ——————  = 4

  $500,000

This would be a really solid Debt-Service Coverage Ratio.  Yay Lisa!  A lender would likely view Lisa as someone who has enough cash available from her business to pay her mortgage.  Keep in mind that lenders may include different things in their calculations of your net revenue and your debt.  They may also have different measures of a strong score depending on your business (e.g, you are just starting out vs. you’ve been around for 10 years).

Probably a good idea to pump the brakes at this point.  That is a lot of math for a single blog post.  Hopefully this helped you dip your toes in the water for another alternative to a conventional loan.  If you need an alternative, it might be a good idea to explore your Debt-Service Coverage Ratio with a lender.  I mean, YOLO.  Might as well go for it.