Central Mortgage Blog

The most important ratio to understand when making income property loans is the Debt Service Coverage Ratio.
It equals Net Operating Income (NOI) divided by the total debt service. To understand the ratio is first necessary to understand the numerator and the denominator. Lets take a look at net operating income (NOI) first.
Net Operating Income is the income from a rental property left over after paying all of the operating expenses: Gross schedule rent $100,000 Less 5% Vacancy Loss $5,000 Effective gross income $95,000 Less Operating Expenses Real Estate Taxes Insurance Repairs and Maintenance Utilities Management Reserves for Replacement Total Operating Expenses $30,000 Net Operating Income (NOI) $65,000 Please note that lenders always insist on some sort of vacancy factor regardless of the actual vacancy rate in order to cover collection loss.
In addition lenders insist on using a management of 3-6% of effective gross income, even if the property is owned-managed.
Their logic is that they would have to pay for management if they took back the property. Finally, note that we have not included loan payments as an operating expense. In the next article we’ll see how it all comes together as we discuss part 2.