Debt Coverage

Have you ever wanted to finance a property, only to hear the term Debt Service Coverage Ratio or Debt Coverage brought up? Debt Coverage is a calculated number that determines your ability to cover your potential debts. Many financial institutions have trusted this debt coverage ratio number in helping them determine whether you are a suitable candidate for financing.


What Is It Used For?

Banks and lenders have to know that they are making a “safe bet” when they hand out money. It does not matter how lucrative the deal may be, they can’t just give away money. Debt coverage is a tool that helps them protect their investments … you are their investment. Debt coverage is calculated based on several factors including on-hand cash and expected costs per month. The closer these two numbers are to each other, the better your debt coverage looks to the lenders.


How To Calculate Debt Coverage

In order to understand the debt coverage calculation, you must first know what the lenders will be using as judgment criteria. They will be looking at the following information to determine your debt coverage ratio:

• Annual Net Income (ANI)
• Amortization/Depreciation (AD)
• Interest Expense (IE)
• Non-Cash And Discretionary Items (NDCI)
• Principal Repayment (PR)
• Interest Payments (IP)
• Lease Payments (LP)

The formula for determining your debt coverage ratio is as follows:

• DCR = (ANI + AD + IE + NCDI) / (PR + IP + LP)

The higher the final debt coverage result is, the better off you will be. For someone who can 100% of the debt, the debt coverage number will be greater than or equal to 1. If your debt coverage ratio falls below 1, lenders are a little more skeptical to provide you with the required financing. Most lenders prefer a debt coverage ratio of 1.1 to 1.5 before they will provide you with a substantial loan/financing offer.


Can I Fix My Debt Coverage Ratio?

Yes you can! If your debt coverage ratio is too low, then you need to find a way to either bring in more money or get rid of your non-cash and discretionary items. You can also attempt to find lower rates in order to keep your interest payments down. Ultimately, your debt coverage ratio can be fixed with the right motivation.


Debt coverage has become an extremely helpful tool for financing institutions. Without debt coverage ratios, lenders would be “flying solo”. As an investor, or a potential home owner, you must understand debt coverage and how it can affect you. The lower your debt coverage ratio, the less likely you are to get the necessary financing. Most individuals will never hear too much about debt coverage; really, it never comes up unless the fees will be high or you aren’t within the accepted debt coverage ratio threshold. Either way, with the way the banks have been lately, it is important to understand the necessity of debt coverage calculations. Remember, the money the banks are lending is really your money. Do you want your money being thrown out the window?