DSCR (Debt-Service Coverage Ratio) is defined as the cash flow necessary to pay debts - interest, principal, lease payments, etc. It is used by lenders to determine loans on income properties. DSCR requirements are different for different types of HUD multifamily loans, however, HUD 223(a)(7) loans are subject to a maximum DSCR of 1.11x (for-profit entities) or 1.05x (nonprofit entities).

When applying for an SBA Express loan, lenders almost always check your "DSCR." For those who are unfamiliar with the term, debt service coverage ratio (DSCR) refers to the borrower's ability to repay debt obligations. Debt service is the money needed to cover both interest and principal in a payment period. The ratio is a formula that divides the net operating income of a business by the total debt service amount:

DSCR = Net Operating Income / Total Debt Service

So, a business with a DSCR of less than 1 does not have sufficient funds to pay back debt obligations, while a business with a DSCR of greater than 1 does.

DSCR (Debt-Service Coverage Ratio) is calculated by dividing the net operating income (NOI) of a property by the total debt service (principal and interest payments) of the property. The resulting ratio is used by lenders to determine the loan amount for income properties. According to HUD Loans, you can use their DSCR calculator to calculate your property's debt service coverage ratio.

In most commercial real estate financing cases, lenders prefer properties with DSCRs of 1.25x or more, but a lender’s DSCR requirements depend on a combination of the borrower’s financial strength, the type of property, and other factors. For example, while lenders may require a minimum DSCR of 1.25x for multifamily properties, property types normally deemed riskier than multifamily properties — such as hotels or retail assets — could see that requirement expand as high as 1.40x or 1.50x. (www.hud.loans/dscr-calculator)

When a lender is evaluating a borrower for a multifamily or commercial real estate loan, DSCR is one of the most important factors that they will take into account. This is because it’s one of the best predictors of whether a borrower will be able to pay back a loan on time. In most cases, lenders prefer properties with DSCRs of 1.20x or more, though the required DSCR will typically depend on the financial strength of the borrower, the type of property in question, and other factors. For instance, while multifamily apartment properties may need a minimum DSCR of 1.20x to qualify for funding, riskier property types, such as hotels or self-storage facilities, may need a DSCR of 1.40x- 1.50x in order to qualify. (www.multifamily.loans/debt-service-coverage-ratio)

In summary, a good DSCR for commercial real estate financing is typically 1.25x or higher, depending on the type of property and the financial strength of the borrower. Riskier properties may require a higher DSCR of 1.40x-1.50x.

Having a high DSCR (Debt-Service Coverage Ratio) is beneficial for borrowers because it indicates that they have sufficient cash flow to cover their debt obligations. A DSCR of 1.25 or higher is often considered “strong” by lenders, and it is a sign that the borrower is in a good financial position. A high DSCR also indicates that the borrower is less likely to default on their loan, as they have the necessary cash flow to cover their debt payments. Additionally, having a high DSCR can help borrowers qualify for more favorable loan terms, such as lower interest rates and longer repayment periods.

Sources:

• HUD 223(a)(7) Loans - DSCR (Debt-Service Coverage Ratio) Definition
• Apartment Loans - DSCR Calculator

The most important risk of having a low DSCR is that the borrower may be unable to cover the costs of their debt obligations without needing to borrow more. A DSCR of less than 1.00 reflects a negative cash flow, which, to lenders means that the borrower will be unable to cover the costs of their debt obligations without needing to borrow more. Even if the debt-service coverage ratio is higher than, but still too close to 1.0, then the borrower is considered to be vulnerable, as any minor decline in cash flow could render them unable to service their debt.

For these reasons, the majority of Lenders in many cases require that the borrower maintain a minimum DSCR to qualify, and sometimes even a DSCR threshold while the loan is outstanding. In these cases, a lender will consider a borrower who falls below that minimum to be in default.

For more information, please refer to Apartment Loans' DSCR Calculator and HUD 223(a)(7)'s DSCR Definition.

For small business financing, there are several alternatives to DSCR (Debt-Service Coverage Ratio). These include:

• SBA 7(a) Loan Program - This program provides loans of up to $5 million to small businesses. The loan terms are based on the borrower's creditworthiness and the amount of the loan.
• SBA Microloans - This program provides loans of up to $50,000 to small businesses. The loan terms are based on the borrower's creditworthiness and the amount of the loan.
• SBA 504 Loan Program - This program provides loans of up to $5 million to small businesses. The loan terms are based on the borrower's creditworthiness and the amount of the loan.
• SBA CDC/504 Loan Program - This program provides loans of up to $5 million to small businesses. The loan terms are based on the borrower's creditworthiness and the amount of the loan.