The Debt Service Coverage Ratio (DSCR) is a measure of how much income you can use to pay down a loan. It’s calculated by dividing the number of your monthly debt payments by the amount of your monthly income.
How DSCR Works
The Debt Service Coverage Ratio is a good indicator of how much income you have available to pay down your loans. It helps lenders determine how much financial flexibility you have to make payments on your debt and whether those payments will be sustainable.
With a good DSCR, you’ll be able to cover all your debt payments, including your mortgage. The DSCR is calculated by dividing the number of your monthly debt payments by the amount of your monthly income. The ratio is then multiplied by 100. A DSCR of 60% or higher means you’re paying 60% of your income on your debt.
The lower your DSCR is, the better—it means you have more income available to pay down your loans. You’ll also have more money to spend, which can help you pay off your debts faster and make it easier to gain pre approval for mortgage from various lenders.
Why DSCR Is Important
A high DSCR means you have more income to use to pay down your loans. It’s a good sign that you have enough income to cover all your monthly payments—including your mortgage. You can then use that extra money to save for retirement or other financial goals.
Unfortunately, many borrowers don’t realize how important a high DSCR is. They borrow too much, or they don’t even calculate their DSCR at all.
If you are borrowing too much, it can be hard to make enough money to cover your loan payments.
That can lead to situations where you’re making only minimum payments on your loans or, worse, defaulting on them altogether. If you don’t calculate your DSCR, there’s no way to know if you’re borrowing too much.
On the other hand, borrowers who calculate their DSCR and compare it to their monthly payments may find that they are borrowing too much—and then they can start paying down their loans.
How to Calculate The DSCR
Calculating your DSCR is easy and free to do online.
Here’s how it works:
- Enter the amount of your monthly debt payment (including your mortgage). If you don’t know exactly how much your debt payment is, enter the amount you think it is (but don’t assume that it’s correct).
- Enter the amount of your monthly income (including any other sources of income). If you don’t know exactly how much your income is, enter the amount you think it is (but don’t assume that it’s correct).
What Factors Affect DSCR
There are several factors that affect the DSCR:
- Credit Score: The higher your credit score, the better because it means you’re less likely to default on your loans.
- Mortgage Rate: The lower the rate you pay on your mortgage, the better because it means you save money on interest payments.
- Loan Amount: The more money you borrow, the lower the DSCR will be (since the higher the payment, the lower the DSCR).
- Down Payment: If you put down a larger down payment on your home than you need to, that will help improve your DSCR (since the larger down payment lowers the loan amount).
How DSCR Affects Your Loan Appraisal
Your loan appraisal will include a calculation of your DSCR—if it’s bad, then it could hurt your loan approval chances—so make sure that it’s high enough to meet all of your loan requirements and still leave some money leftover for savings and other financial goals, like retirement or college tuition payments.
If it’s not high enough, then lenders may reject your loan application—and that could hurt any chance you have of getting a mortgage for any other lender in the future.
Example of DSCR Calculation and Impact on Appraisal
Let’s look at an example of a borrower who wants to buy a home for $250,000 with a 30% down payment (so $75,000). That borrower has a credit score of 760 and a mortgage rate of 4%.
Let’s assume that this borrower has an average salary of $50,000 and an average credit card balance of $2,000 per month (that’s $40,000 in total credit card debt) and that this borrower expects to spend $50,000 per year on non-mortgage debt (such as auto loans). The borrower will also have $5,000 in monthly student loan payments and $5,000 per month in medical debt payments (assuming this borrower has no other medical bills).
The borrower will have $30,000 in monthly mortgage payments but only $20,000 in monthly debt payments (assuming the borrower has no other debt payments).
Why You Should Check Your DSCR And Not Just Your Mortgage
You should check your DSCR at least once every two years and make sure it’s high enough to cover all of your loan payments and retirement or college tuition payments. If it isn’t high enough, then lenders may reject your loan application, and that could hurt any chance you have of getting a mortgage for any other lender in the future—or even giving you another loan in the future if you find yourself in another rough financial situation later on in life.
Remember to check your DSCR and make sure it’s high enough to cover all of your loan payments and still leave some money leftover for savings and other financial goals like retirement or college tuition payments. If it isn’t high enough, then lenders may reject your loan application, and that could hurt any chance you have of getting a mortgage for any other lender in the future.
