Let’s talk about a common misunderstanding made by borrowers when researching and applying for a commercial mortgage loan is how they calculate Net Operating Income (NOI). Many borrowers do not realize that commercial lenders use actual expenses plus anticipated holdbacks (i.e. vacancy rate, repairs and maintenance, management, etc.) Holdbacks can also be thought of as unexpected or anticipated future expenses.Many commercial mortgage borrowers forget, and the commercial mortgage underwriter does not, is that the expenses and holdbacks are a necessary factor should the property go into default. These are expenses and possible costs that will affect not only how the loan is repaid; but, how the property will be managed should the property come back to the lender through default.Let’s use a basic example of how a commercial mortgage lender is going to calculate DSCR using the holdbacks. The holdbacks in this example are in italics, while these are not direct expenses that are paid out, they are deducted from the Gross Income.Now you have the Net Operating Income (NOI), then you need to determine the DSCR. DSCR is simply the amount of the commercial mortgage loan payment in P&I (principle and interest) only. As you can:Gross Rent: $1,000,000Other income: $0Annual Gross Income: $1,000,000Less 5% Vacancy: $50,000Effective Gross Income: $950,000Property Taxes: $10,000Maintenance: $2,000Insurance: $2,000Utilities: $2,000Janitorial Service: $2,000Less 5% Mgt Reserve: $50,000Total Operating Expenses: $68,000Effective Gross Income: $950,000Less Total Operating Expenses: $68,000Net Operation Income (NOI): $882,000see from the example above the taxes and insurance are included when determining the NOI.Example of Debt ServiceCommercial Mortgage Loan: $5,000,000 First MortgageInterest Rate: 5.5%Term: 30 YearsMonthly P&I Payment: $28,389Debt Service (Annual Payments) = $340,673Now we have all the parts of the puzzle, let’s calculate the Debt Service Coverage Ratio (DSCR):DSCR=NOI/DSDSCR = $882,000 / 340,673DSCR = 2.58%In this case, this shows a commercial mortgage underwriter that the cash flow generated by the property covers the new commercial loan payment by 2.59x.Now as you look at this example, if the DSCR is 1.0 then you can presume the property generates enough revenue to break even. If the number is negative (i.e. -1.2) then that will alert the commercial lender to a net operating loss.I hope this has given you an overview what DSCR means and how to calculate your Debt Service Coverage Ratio.