What it is
Debt service is the cash a borrower owes the lender to keep a loan current. On an amortizing loan it is principal plus interest. On an interest-only loan it is interest alone. Commercial real estate underwriting almost always talks about it on an annual basis, because it gets compared to annual NOI.
How it's calculated
For a fixed-rate amortizing loan, the monthly payment depends on three things: the loan amount, the interest rate and the amortization period. Multiply the monthly payment by twelve and you have annual debt service.
| Loan | Rate | Amortization | Monthly payment | Annual debt service |
|---|---|---|---|---|
| $10,000,000 | 6.00% | 30 years | $59,955 | $719,460 |
| $10,000,000 | 6.00% | 25 years | $64,430 | $773,160 |
| $10,000,000 | 6.00% | Interest-only | $50,000 | $600,000 |
The figures are illustrative. Shorter amortization means bigger payments, even at the same rate.
The mortgage constant
Annual debt service divided by the loan amount is called the loan constant or mortgage constant. In the first row above it is about 7.19%. Lenders use the constant to size loans quickly: divide the NOI the property can spare for debt by the constant and you get the maximum loan. The loan sizing calculator does this for you.
How lenders use it
Debt service is the denominator of the DSCR. A lender that requires 1.25x coverage on $1,000,000 of NOI is saying annual debt service cannot exceed $800,000. Everything else in the sizing follows from that.
Floating-rate loans complicate the picture. Payments move with SOFR, so lenders often underwrite debt service at a stressed rate or require an interest rate cap. Interest-only loans are frequently tested on a hypothetical amortizing payment as well.
Common mistakes
- Mixing monthly and annual figures. Dividing annual NOI by a monthly payment produces a DSCR twelve times too high. It happens more than you'd think.
- Leaving out the second loan. If there is mezzanine debt or seller financing, lenders look at combined coverage as well as senior coverage.
- Using the teaser rate. Show debt service at the rate the lender will actually underwrite, not the best case.
In the package
State the loan amount, rate assumption, amortization and resulting annual debt service in one place, and make sure every page of the package uses the same numbers. When the underwriting model and the deck are built from the same record, they can't drift apart.