If you are considering getting a loan for your business, you probably want to know your chances of approval beforehand, right? The key to understanding your chances of getting a loan approved is to determine your debt service coverage ratio. This ratio is used by lenders to forecast the likelihood that you would be unable to pay your loan on time with your current finances. To make things a little more complicated, there are two types of debt service coverage ratio: gross and total. To give you a better idea on how to calculate your debt service coverage ratio, we will briefly discuss both types and how they are calculated.
The Two Types of Debt Service Coverage Ratio
Debt Service Coverage Ratios are divided into gross debt service coverage (GDS) and total debt service coverage (TDS). Each one is calculated differently, and it is important to know how to figure out both:
GDS: Your GDS is calculated by taking all of your monthly housing payments (mortgage, rent, property housing, HOA fees, etc.) and dividing it by your gross monthly income. Once you get that figure you just multiply it by 100 and you will have your gross debt service coverage ratio. A good rule of thumb is that your GDS should be 30% or lower.
TDS: Your TDS is calculated by taking all of your monthly debts (such as previous business loans, business credit cards, and the housing payments mentioned above) and dividing them by your gross income. Multiplying that figure by 100 will give you your total debt service coverage ratio. Typically, your TDS should not be higher than 40%.
How You Would Calculate Debt Service Coverage Ratios (With Numbers)
To better illustrate how you would go about calculating your TDS and GDS, consider the case of one Julio Garcia. Mr. Garcia owns a cafe and is considering taking out a business loan to implement a new delivery service. He currently pays $2,000 per month as a mortgage for his cafe building, $500 per month for his business credit card, and $300 per month on a previous business loan. Mr. Garcia currently earns a gross income of approximately $8,000 per month.
To find out Mr. Garcia’s GDS, we would take $2,000 and divide that by $8,000 which comes out to .25. If we multiply that by 100, we now know that Mr. Garcia’s GDS is 25% (which is under 30% as recommended).
To figure out Mr. Garcia’s TDS, we will add his monthly payments of $2,000, $500, and $300 ($2,800) and divide that by $8,000 to get .35. If we multiply that by 100, we know that Mr. Garcia’s TDS is 35% (which is under 40% as recommended).
We hope that this article has given you a better idea of what a debt service coverage ratio is and how you can calculate it. Keep in mind that your debt service coverage ratio is only part of what lenders will consider when you apply for a business loan. Still, it is an important concept to learn.