We discussed the meaning of debt coverage ratio as it relates to real estate cash flow in our last article. Now let’s see how to calculate it.
CALCULATION: Debt Coverage Ratio = Net Operating Income / Debt Service
EXAMPLE ONE: Let’s assume a borrower is requesting a mortgage with annual payments of $40,000 on an real estate investment property that generates a net operating income of $50,000. The DCR computes at 1.25 ($50,000 / 40,000 = 1.25).
EXAMPLE TWO: Now let’s assume a mortgage with annual payments of $50,000 on the same net operating income of $50,000. The DCR computes at 1.00 ($50,000 / 50,000 = 1.00).
EXAMPLE THREE: Lastly, let’s assume a mortgage with annual payments of $55,500 on the same net operating income of $50,000. The DCR computes at 0.90 ($50,000 / 55,500 = 0.90).
