What Is Debt Service? Debt service is the cash required to cover the principal and interest payments on a loan or other debt over a specific period (usually a year). It applies to individuals (mortgages, student loans), businesses (commercial loans, bonds), and governments. To "service" debt simply means making the scheduled payments. Debt-Service Coverage Ratio (DSCR) Definition and formula
DSCR measures a borrower’s ability to meet debt obligations from operating income.
Formula: DSCR = Net Operating Income / Total Debt Service
Net operating income (NOI) = income from normal business operations (excludes nonoperating gains).
Total debt service = principal + interest payments due in the period. Explore More Resources
Why it matters
Lenders and bond investors use DSCR to assess leverage and repayment capacity.
A higher DSCR indicates more cushion to absorb debt payments and take on additional debt.
A DSCR less than 1 means operating income is insufficient to cover debt service and signals financial stress. Example
ABC Manufacturing has NOI of $10 million from furniture sales. Its annual principal + interest payments total $2 million.
* DSCR = $10M / $2M = 5.0 — a strong coverage ratio that indicates capacity to take on more debt. Explore More Resources
What Is a Good DSCR?
* Higher is better. Lenders commonly look for at least 1.25 for commercial loans.
* DSCR = 1.0 means all operating income goes to debt payments — little margin for error.
* DSCR < 1.0 suggests the borrower is paying more in debt service than it earns from operations and may be unsustainable.
Debt-to-Income (DTI) Ratio — Personal Equivalent
* DTI measures an individual’s ability to service debt: DTI = Total monthly debt payments / Gross monthly income.
* Example: $5,000 monthly income with $2,000 monthly mortgage = 40% DTI.
* Acceptable DTI thresholds vary by lender and loan type; lower DTI is generally viewed more favorably.
Loan Servicing vs Debt Servicing
* Loan servicing: administrative tasks performed by lenders or servicers (billing, payment processing, statements).
* Debt servicing: the borrower’s act of making payments to reduce principal and interest.
How Debt Decisions Affect a Business
* Leverage and capital structure: Debt vs. equity decisions determine how a company finances assets.
* Companies with stable, predictable earnings (e.g., utilities) can carry higher debt loads because they reliably generate the cash needed for debt service.
* Firms with volatile earnings may need to raise funds through equity rather than debt.
* Overleveraging (too much debt relative to income) increases default risk and limits future borrowing options.
Key Takeaways
* Debt service = payments of principal + interest over a period.
* DSCR evaluates whether operating income covers debt service; lenders often seek DSCR ≥ 1.25.
* DTI is the personal-finance analogue to DSCR and varies by lender.
* Loan servicing is administrative; debt servicing is the borrower’s payment obligation.
* Maintaining adequate coverage and consistent earnings is essential to safely carry and raise debt.