IRA Loan Debt Service Coverage is the ability of the rental property that the self directed IRA (the Plan) owns to generate enough income or rental stream to pay all the operating expenses of the property and the loan payments with a cushion. A Non Recourse loan can only be paid back by the income and liquid assets in the Plan. So when a lender is evaluating whether or not to make a non recourse loan, that lender and you should look at all the operating expenses the property has such as taxes, vacancy factor (we use 7% of gross rents), insurance, any HOA Fees, maintenance, and any other operating expense the IRA is obligated to pay.
Take the gross income the property will generate and subtract the operating expenses listed above, and that will get you to Net Operating Income. This term is used throughout the real estate investing world to measure whether or not the property generates a profit. From this Net Operating Income will come the loan payment if there is debt on the property. At First Western Federal Savings we have a minimum Debt Service Coverage ratio of 1.25. What this means is that the Net Operating Income is at least 125% of the loan payment, insuring there is a positive cash flow cushion going back into the IRA or self directed retirement plan every month, or at least on an annual basis. That is what you want right? Positive cash flow into your Plan. An example would be if there was rental income each month of $1200 and operating expenses of $500, that would leave $700 per month for debt service. Say the loan payment was $500 as well.
Net Operating Income (NOI) in this example would be $1200-$500 in expenses for NOI of $700. $700 income divided by a $500 loan payment would be a 1.4 debt service coverage ratio, or to say it another way, the $700 NOI is 140% of the $500 loan payment.
And that’s how debt service coverage is computed. See my other example on the Learning Center of our website for more detail.