Written byThe debt service coverage ratio (DSCR) is a lending measure that divides the cash flow available for repayments by the debt repayments due over the same period.
Also known as: DSCR, debt service cover ratio, debt servicing ratio
Key points
- A ratio above 1.0 means earnings cover the repayments; below 1.0 means they do not.
- It is normally built from net operating income or earnings before interest, tax, depreciation and amortisation, not from revenue.
- Every lender sets its own minimum in credit policy, and the required headroom moves with credit risk and industry.
- A weak ratio can often be lifted by a longer term, a larger deposit or clearing other debt.
- Brokers use it early to work out which lenders a business deal actually suits.
How the ratio works
Start with the earnings a business has available to service debt over a period, usually a full year. Lenders normally use net operating income, or earnings before interest, tax, depreciation and amortisation, because those figures show what the business produces before financing costs are taken out. Then add up the debt service due over the same period: the principal and interest payable on every facility, not just the new one.
Divide the first number by the second. A result of 1.0 means earnings exactly match the repayments, with nothing spare. A result of 1.25 means the business earns a quarter more than it needs to pay. Anything under 1.0 means the repayments cannot be met from trading earnings alone.
How lenders read it
Every lender sets its own minimum, and the number moves with the type of finance and the perceived risk. Property-backed commercial lending is usually assessed differently from unsecured cash flow lending, and a business with lumpy seasonal income is generally asked for more headroom than one sitting on long-term contracts.
Lenders also stress the ratio rather than taking it at face value. They may assess repayments at a higher rate than the one on offer, add back or strip out directors' drawings, and remove one-off income before deciding. Some facilities carry covenants requiring the ratio to stay above an agreed level for the life of the loan, with figures reported each quarter or year.
Where DSCR is used
DSCR turns up most in commercial and business lending: equipment finance for larger assets, commercial property, and working capital facilities. It is one of the first numbers a credit assessor calculates, because it answers the simplest question in the file: can this business pay?
Consumer lending asks the same question under a different name. Household affordability is tested through income, living expenses and existing commitments with a buffer applied, rather than through a single ratio. The logic is identical: repayments should be met from regular income with room to spare if conditions change.
Example
A landscaping business applies for an excavator loan. Its net operating income for the year is $180,000. It already pays $60,000 a year on a truck loan, and the new repayments would add another $60,000, so total debt service is $120,000. The DSCR is 1.5, meaning earnings are one and a half times the repayments. If the business chose a shorter term and repayments rose to $180,000 a year, the ratio would drop to 1.0 and most lenders would want a longer term, a bigger deposit or extra security before going ahead.
Not to be confused with
- Loan-to-value ratio (LVR)
- measures the loan against the value of the security, not whether earnings cover the repayments
- Affordability
- a broader consumer test of income and expenses rather than a single business ratio
Frequently asked questions
What does DSCR mean in lending?
DSCR stands for debt service coverage ratio. It compares the earnings a borrower has available with the loan repayments falling due over the same period. Lenders use it as a quick read on whether a business can carry the debt it is asking for.
How do you calculate the debt service coverage ratio?
Divide the earnings available to service debt, usually net operating income or EBITDA, by the total principal and interest payable over the same period. Include existing facilities, not just the new loan. A result of 1.2 means earnings are a fifth higher than the repayments.
What is a good DSCR?
Anything above 1.0 means earnings cover the repayments, and lenders generally want a buffer above that so a bad quarter does not tip the business over. The minimum varies by lender, industry and security offered, so ask your broker what each lender expects.
What happens if my DSCR is too low?
The application may be declined, or approved on different terms. Common fixes are a longer loan term to bring repayments down, a larger deposit, paying out or consolidating other debt, or offering more security. Updated figures showing stronger recent trading can also change the assessment.
Is DSCR used for personal loans?
Not usually by that name. Consumer lenders test affordability through income, living expenses and existing commitments, with a buffer added to the assessment rate. The principle matches DSCR: repayments should be comfortably met from regular income, with room left if circumstances change.
Related terms
Affordability
Affordability is whether a person or household can meet the cost of a good, service or loan repayment without giving up essentials or taking on debt they cannot sustain.
Read definitionCash flow
Cash flow is the movement of money into and out of a business over a period; unlike profit, it tracks actual receipts and payments, so it measures liquidity.
Read definitionCredit risk
Credit risk is the possibility that a borrower or counterparty will default on their contractual repayments, leaving the lender or investor with a loss.
Read definitionUnderwriting
Underwriting is the process a lender or insurer uses to verify an application, assess the risk and decide whether to approve, decline, or approve with conditions and pricing.
Read definitionLoan-to-value ratio (LVR)
A loan-to-value ratio (LVR) is the amount you borrow as a percentage of the value of the security, usually property, and a key measure of lending risk.
Read definitionCovenants
Covenants are promises, obligations or restrictions written into a contract or recorded on land title that bind the parties, such as a borrower's promise to maintain minimum interest cover.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.