No one gets wealthy without using debt, especially in real estate. Accurately determining the debt coverage ratio (DCR) will give you a good indication of whether your deal will be profitable and if you can get lending from the bank.
Let’s go over why this number matters so much to the bank — and you — and how to calculate it the right way.
Debt coverage ratio can make or break your financing
Lenders look at the DCR of an asset when deciding whether or not to give you financing. They believe it shows if the property will be profitable enough for you to pay them back… with interest.
So, obviously, this figure is significant to the loan officers. In addition, it means that this number can tell you if your deal will cash flow as well before you even decide to talk to a bank.
Nevertheless, this number can’t help you if you don’t know how to calculate it correctly.
How to calculate debt coverage ratio
There are no real estate numbers that can help you create wealth if the math is done wrong. That being said, I’m going to give you the correct formula to calculate debt coverage ratio.
DEBT COVERAGE RATIO (DCR) = net operating income (NOI) ÷ yearly debt obligations
Essentially, banks are looking for somewhere between 1.15-1.25 to lend money for. That means you’ll make 15 to 25% what you owe them per year to own this property. They call that a “spread.” And a spread like this covers paying the bank and yourself.
In summary, I believe that real estate is the best way for Americans to build wealth today. However, you have to understand the terms and the math. One of those is DCR.
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Use this information well, get better deals, and be great,