When a lender sizes a loan on a rental, one of the main questions is whether the property's income covers the payment with room to spare. Debt service coverage ratio (DSCR) is the number that answers it. The catch is that lenders do not all calculate it the same way, so one house can produce more than one ratio. This guide runs one deal through the math, using the DealLitmus DSCR calculator's default numbers. All figures are pre-tax.
The deal
The house is the rental property calculator's default: a $240,000 purchase with 25% down.
- Loan amount: $180,000 at 7% for 30 years
- Rent: $2,400 a month
- Vacancy: 5%
- Operating expenses: $9,000 a year (taxes, insurance, repairs and management, but not the mortgage)
Step 1: find net operating income
Net operating income (NOI) is the rent you expect to collect minus the cost of running the property, before any loan payment.
- Gross rent: $2,400 × 12 = $28,800
- Vacancy: 5% of $28,800 = $1,440
- Rent after vacancy: $27,360
- Operating expenses: $9,000
NOI = $27,360 minus $9,000 = $18,360 a year
Step 2: find annual debt service
Debt service in this version means principal and interest only. On a $180,000 loan at 7% over 30 years it comes to $14,371 a year, or about $1,198 a month.
Step 3: divide one by the other
DSCR = NOI ÷ annual debt service = $18,360 ÷ $14,371 = 1.28
How to read the number
- Below 1.0: the income does not cover the payments, and you make up the gap out of pocket.
- Around 1.2 to 1.25: a common minimum, though the floor varies by lender and loan program. Some programs accept 1.0 or lower, often with a higher rate or a larger down payment.
- Above 1.5: a wide cushion. A slow month or a rent cut is less likely to put the loan at risk.
At 1.28, this deal clears a 1.25 minimum, but not by much.
Why your expense estimate matters
The rental property calculator analyzes the same house and loan but builds expenses line by line: $2,900 in property taxes, $1,400 in insurance, 10% of rent for repairs and CapEx, and 8% for management. That produces NOI of $17,991 instead of $18,360 and a DSCR of 1.25 instead of 1.28. Only the expense estimate changed, and the deal went from a small margin to sitting right at a 1.25 minimum. At that level the calculator shows $302 a month of pre-tax cash flow.
Two conventions, and why you have to ask
- NOI over principal and interest. This is the version above, and the one DealLitmus calculators use. It is common in commercial lending.
- Gross rent over the full payment. Many DSCR loan programs for small residential rentals divide monthly rent by the whole housing payment: principal, interest, taxes, insurance and any HOA dues (PITI plus HOA). Typically nothing is deducted for vacancy, repairs or management.
This deal has no HOA dues, so the second version puts the full $2,400 of rent over about $1,198 of principal and interest plus one month's share of the $2,900 in taxes and $1,400 in insurance. The result is higher than 1.28, mainly because vacancy, repairs and management are never subtracted from the rent.
So a quoted minimum means little until you know the formula behind it. Ask your lender what goes on top, what goes on the bottom, and whose rent figure they use. Some use the lease, others the appraiser's estimate of market rent, or the lower of the two.
The largest loan this income supports
Run the formula backward. Divide NOI by the lender's minimum ratio to get the most debt service the income can carry, then find the loan amount whose payment equals that figure at your rate and term.
Largest loan at a 1.25 DSCR, 7% and 30 years on $18,360 of NOI = $183,976
That is only a little above the $180,000 being borrowed, which is what a ratio just over the minimum looks like. Start from the lower $17,991 NOI and the ceiling drops.
How to improve a weak DSCR
- Raise income. Bring rent up to market, or shorten the gaps between tenants.
- Cut operating costs. Shop the insurance policy, review the management fee, and fix what causes repeat repair calls.
- Shrink the payment. Borrow less (a lower price or a larger down payment), get a lower rate (sometimes by paying points), or ask whether a longer amortization or an interest-only period is available.
What this analysis leaves out
- The lender's inputs decide the loan, not yours. They may use their own rent figure, actual tax and insurance bills, and their own vacancy assumption.
- It is a one-year snapshot. Taxes and insurance often rise, rents can fall, and an adjustable rate can reset.
- Big replacements may be missing. If your expense figure has no allowance for a roof or furnace, the real cushion is thinner than the ratio suggests.
- DSCR measures safety, not return. The 1.25 version of this deal earns a 5.4% pre-tax cash-on-cash return on $67,200 of cash (the down payment plus 3% closing costs).
- It is one test among several. Lenders commonly also look at loan-to-value, credit and cash reserves.
Every figure here is pre-tax, and none of it is tax or legal advice.
Run your own numbers
Put your deal into the DSCR calculator to see the ratio and the largest loan your income supports. Use the rental property calculator to build NOI from itemized expenses. The DSCR glossary entry has the short version.