What is the Required Debt Service Coverage Ratio (DSCR) for SBA 7(a) Loans?
Debt service coverage ratio, or DSCR, is one of the most important factors lenders look at when approving a loan. DSCR is calculated by dividing a business’s net operating income by their total debt service. For SBA 7(a) financing , most lenders want a borrower to have a DSCR of 1.25x or more.
Debt service coverage ratio, or DSCR, is one of the most important factors lenders look at when approving a loan. DSCR is calculated by dividing a business’s net operating income by their total debt service. For SBA 7(a) financing, most lenders want a borrower to have a DSCR of 1.25x or more.
How The DSCR Formula Works in Practice
In order to better understand how DSCR works, let’s look at some numbers. For example, if a business has $1 million of net operating income (NOI), and an annual debt service of $750,000, they would have a DSCR of 1.33x.
$1 million/$750,000 = 1.33x DSCR
That 1.33x DSCR is slightly above most lenders’ minimum requirement of 1.25x, so, if the borrower were otherwise eligible for an SBA 7(a) loan, their DSCR would not typically be a limiting factor.
DSCR Calculator
6 Tips on How to Improve DSCR
Increase revenues: This can be done by expanding the customer base, increasing prices, or introducing new products or services.
Reduce expenses: A company can look for ways to cut costs, such as negotiating lower prices for supplies, reducing overhead, or streamlining operations.
Pay down debt: Paying off existing debt will reduce the amount of debt the company has to service and improve the DSCR.
Refinance debt: If the company is unable to pay off its existing debt, it may be able to refinance it at a lower interest rate, which will reduce the amount of money needed to service the debt and improve the DSCR.
Increase the time period over which debt is repaid: Extending the repayment period will reduce the amount of money needed to service the debt each month, improving the DSCR.
Increase equity: A company can improve its DSCR by increasing the amount of equity it has relative to debt. This can be done by retaining earnings, issuing new stock, or selling assets.
DSCR is Especially Important for Commercial Real Estate Loans
While DSCR is important for all kinds of SBA 7(a) loans, it’s particularly important for SBA 7(a) loans for commercial real estate. Some lenders may even offer eligible borrowers 100% financing for commercial real estate with the 7(a) loan. However, this requires great credit, strong financials, and a high DSCR, among other factors.
Related Questions
What is the DSCR requirement for SBA 7(a) loans?
The required Debt Service Coverage Ratio (DSCR) for SBA 7(a) loans is typically 1.25x. This means that the business must have a net operating income (NOI) that is 1.25 times greater than the annual debt service.
For example, if a business has $1 million of net operating income (NOI), and an annual debt service of $750,000, they would have a DSCR of 1.33x.
$1 million/$750,000 = 1.33x DSCR
DSCR is especially important for commercial real estate loans. Some lenders may even offer eligible borrowers 100% financing for commercial real estate with the 7(a) loan. However, this requires great credit, strong financials, and a high DSCR, among other factors.
What is the difference between DSCR and debt-to-income ratio?
Debt Service Coverage Ratio (DSCR) is a measurement of an entity’s cash flow vs. its debt obligations. It is typically used to assess risk in approving a new loan. In contrast, debt-to-income ratio is a measure of an individual's total monthly debt payments divided by their gross monthly income. It is typically used to assess an individual's ability to manage their debt.
For more information on DSCR, please see this article and this article.
How does the DSCR affect the amount of an SBA 7(a) loan?
The Debt Service Coverage Ratio (DSCR) is an important factor in determining the amount of an SBA 7(a) loan. Generally, lenders require a minimum DSCR of 1.25x for SBA 7(a) loans. A higher DSCR may be required for commercial real estate loans, and some lenders may even offer 100% financing for commercial real estate with the 7(a) loan. However, this requires great credit, strong financials, and a high DSCR, among other factors.
The DSCR is calculated by dividing the business's net operating income (NOI) by its annual debt service. For example, if a business has $1 million of net operating income (NOI), and an annual debt service of $750,000, they would have a DSCR of 1.33x.
$1 million/$750,000 = 1.33x DSCR
What other factors are considered when applying for an SBA 7(a) loan?
When applying for an SBA 7(a) loan, the lender will evaluate your creditworthiness based on a number of factors:
- You must be able to show that you can pay your business expenses, a draw for yourself and the loan payment the income generated by the business. The lender will ask to see sales records for prior years and cash flow projections.
- If you are operating a start-up, the lender will have questions about your prior business experience and education to determine that you have the know-how to successfully operate the type of business you wish to start.
- Business owners need to invest a significant amount of money in their own company before they can seek outside funding. For a startup, the lender will want to see a minimum of $1 of the owner’s money invested in the business for $3 of loan funding. For an established business, the lender is looking for a maximum of $4 of debt to $1 of net worth for the business.
- The lender will check your personal and business credit histories. You are more likely to be approved if your credit report shows that you have a history of meeting your credit obligations as agreed. If there are any blemishes on your credit reports, be prepared to explain them to the lender in detail.
- In addition to the eligibility requirements, there are a few additional qualities which can increase your likelihood of SBA 7(a) loan approval:
- A good credit score - preferably above 680.
- A history free from recent bankruptcies, foreclosures, or tax liens.
- Having been in business for at least two years.
- The ability to provide collateral for loan requests over $25,000.
- The ability to make a down payment of 10% if your intended use of funds is to purchase a business, commercial real estate, or business-related equipment.
- Sufficient cash flow to meet your debt obligations.
- Sufficient working capital (once you subtract liabilities from assets).
- “Good character” according to the SBA (partially decided based on your track record of managing your resources and day-to-day business affairs).
What is the maximum loan amount for an SBA 7(a) loan?
The maximum loan amount for an SBA 7(a) loan is $5 million. If you borrow the maximum, the SBA will be funding $3,750,000 of the loan and your private lender will cover the rest.
Source: SBA 7(a) Loan Calculator