Why Lenders Require a DSCR of 1.25 or Higher
A DSCR of 1.0 means you break even—your operating income exactly covers your debt payments with nothing left over. Lenders do not find that comforting. They know that revenue fluctuates, expenses spike, and surprises happen. A DSCR of 1.25 means you generate 25% more income than your debt payments require, giving the lender confidence that you can still make payments even if business dips.
According to the FDIC, bank examiners evaluate commercial loan portfolios partly based on the borrowers' debt service coverage. Loans to borrowers with a DSCR below 1.0 are typically classified as “substandard,” which increases the bank's regulatory burden. This is why most banks will not approve loans to businesses that cannot demonstrate at least 1.25.
SBA Loan Requirements: The 1.15 Minimum
The U.S. Small Business Administration sets a minimum DSCR of 1.15 for most SBA-guaranteed loans. This is lower than what conventional banks typically require because the SBA guarantee reduces the lender's risk. However, individual SBA-approved lenders may set their own higher requirements. In practice, many SBA lenders look for 1.25 or better.
The SBA's 7(a) loan program—the most common type of SBA loan—is designed for working capital, equipment, and real estate. Borrowers must demonstrate the ability to repay from business cash flow, and the DSCR is the primary measure of that ability. If your DSCR is between 1.15 and 1.25, an SBA loan may be your best option since conventional lenders are likely to decline.
How to Improve Your DSCR
The DSCR formula has two inputs: net operating income in the numerator and debt payments in the denominator. You can improve the ratio by increasing one or decreasing the other.
Increasing net operating income:
- Raise prices. Even a 3–5% increase across the board can significantly move the needle on operating income without losing most customers.
- Cut operating expenses that do not directly drive revenue. Review subscriptions, renegotiate vendor contracts, and eliminate underperforming marketing channels.
- Improve operational efficiency. Faster project completion, better scheduling, and reduced waste all increase income without increasing revenue.
- Add higher-margin services or products. Shifting your revenue mix toward higher-margin offerings improves NOI even at the same revenue level.
Reducing debt payments:
- Refinance at a lower rate. If rates have dropped since you took the loan, or if your credit profile has improved, refinancing reduces your annual debt service.
- Extend the loan term. Spreading payments over a longer period reduces the annual obligation. This increases total interest paid, but it improves your DSCR immediately.
- Pay off small, high-payment debts. Eliminating a small loan with disproportionately large payments can meaningfully reduce your denominator.
- Consolidate multiple debts. Combining several loans into one with a lower blended rate and longer term can reduce total annual payments.
DSCR in Loan Applications
When you walk into a bank with a loan application, the underwriter will calculate your DSCR from your tax returns and financial statements. They typically use the trailing 12 months of actual results, not projections. Some lenders will also project your DSCR after the new loan is added to see if you can handle the additional burden.
The SCORE resource library offers free financial statement templates that can help you organize your numbers before approaching a lender. Presenting clean, well-organized financials with a strong DSCR significantly improves your chances of approval and your ability to negotiate better terms.
One common mistake: owners calculate DSCR using revenue instead of net operating income. Revenue is not income. Your DSCR must use the income left after all operating expenses (excluding interest and taxes). Using revenue overstates your coverage and will not match what the lender calculates from your financials.
What Happens When DSCR Drops Below 1.0
A DSCR below 1.0 means your business is not generating enough income to cover its debt payments. The shortfall must come from somewhere—typically cash reserves, owner contributions, or additional borrowing. None of these are sustainable long-term.
If your existing loan covenants include a DSCR requirement (and most commercial loans do), dropping below the minimum triggers a technical default. This gives the lender the right to accelerate the loan—demanding full repayment immediately—or to impose additional restrictions on your business. In practice, most lenders will work with you on a plan, but you lose all negotiating leverage.
If you see your DSCR trending toward 1.0, act before it gets there. Contact your lender proactively, present a plan to improve coverage, and demonstrate that you are managing the situation. Lenders respond far better to borrowers who communicate early than to those who wait until they miss a payment.
Sources
- U.S. Small Business Administration — Loan Programs — SBA loan requirements, DSCR minimums, and eligibility criteria
- FDIC — Resources for Bankers — Bank examination standards and commercial lending guidelines
- SCORE — Templates & Resources — Free financial statement templates and loan preparation worksheets