Real estate sponsors often treat DSCR and interest‑only (IO) as if they’re interchangeable features of the same loan. They are not.
- DSCR is an underwriting test: does the property’s cash flow cover the debt payment with a safety cushion?
- Interest‑only is a payment structure: are you paying back principal along the way, or postponing it to the end?
For funds built on government‑backed rent streams—such as voucher‑anchored housing—this distinction becomes even more important. Government payors can make cash flow more predictable, but the wrong debt structure can still create forced‑refinance risk at the worst moment.
1) DSCR: the lender’s safety margin
Debt Service Coverage Ratio (DSCR) measures how comfortably a property can pay its loan.
DSCR = Net Operating Income (NOI) ÷ Annual Debt Service
- NOI = rent collected minus operating expenses (before debt service)
- Debt service = the required loan payments (interest, and sometimes principal)
A DSCR of:
- 1.00× means the property only breaks even on debt payments
- 1.25× means there’s a 25% cushion (a common institutional minimum)
- 1.35×+ is typically “high comfort” for long‑term debt
For voucher‑anchored portfolios, DSCR underwriting can be compelling because collections tend to be reliable, delinquency is typically low, and vacancy can be structurally supported by waitlists and program demand.
Check one of Our Projects in which we came up with the Solution of DSCR to Finance the project.
It is Called COSMOS Fund I
2) Interest‑Only: better DSCR optics, higher refinance dependency
An interest‑only loan means your periodic payments cover interest only, with no principal paydown during the IO period.
That does two things:
- Lowers the payment today → DSCR looks stronger on paper.
- Keeps the loan balance flat → you must repay principal later via sale or refinance.
IO can be useful during ramp‑up or lease‑up phases. But for a fund with a defined life (e.g., 7–10 years), full‑term IO effectively increases reliance on future credit markets. When rates rise or lending standards tighten, that reliance becomes the risk.
3) Why amortization is often the “institutional” choice
An amortizing loan includes both interest and principal in each payment. Over time:
- the debt balance falls,
- the refinance requirement shrinks,
- and equity builds automatically.
For funds backed by government rent streams, amortization is often what turns “stable cash flow” into “durable capital structure.” You may accept a slightly lower DSCR at closing in exchange for significantly lower maturity risk.
Exhibit A — DSCR & exit outcomes (illustrative numbers from our model)
Below is a simple comparison using one of our conservative underwriting snapshots:
- Portfolio size: 100 residential units
- Stabilized rent stream: government‑anchored (voucher‑supported)
- Debt sizing discipline: DSCR and LTV caps
- Loan amount: $17.0M
- Interest rate: 6.00%
- Year‑1 NOI (portfolio): ~$1.73M (modeled cash flow after operating expenses, before financing)
Exhibit A1 — Annual debt service & DSCR
| Structure | Annual Debt Service | Year‑1 DSCR |
|---|---|---|
| Interest‑Only (IO) | $1.02M | ~1.70× |
| 30‑Year Amortizing | ~$1.22M | ~1.41× |
What this shows: IO improves DSCR optics by lowering the payment, but amortization still delivers strong coverage when the NOI is stable.
Exhibit A2 — Loan balance at exit (why amortization matters)
Assuming a 7‑year hold:
| Structure | Estimated Loan Balance at Year 7 |
|---|---|
| Interest‑Only (IO) | $17.0M |
| 30‑Year Amortizing | ~$15.0M (approx.) |
Equity impact: Amortization can reduce payoff by ~$2.0M by Year 7, which typically increases sale proceeds to equity and lowers refinance stress in volatile markets.
Key takeaway: IO loans can be fine tactically—but amortization is what reduces “future market dependence.”
4) The best compromise: short IO, then amortization
For portfolio funds, a common institutional structure is:
- 24–36 months interest‑only (during acquisition ramp / seasoning), then
- 25–30 year amortization for the remainder of the term.
This preserves early cash flow while still paying down principal before exit—improving both lender comfort and sponsor optionality.
5) Practical term‑sheet checklist (what we ask lenders)
When reviewing debt offers, we don’t evaluate rate in isolation. We assess:
- DSCR definition: what is included/excluded in NOI?
- Structure: IO period length, amortization schedule, maturity options
- Prepayment: step‑down vs. yield maintenance/defeasance
- Recourse: non‑recourse vs. limited carveouts
- Portfolio rules: scattered‑site tolerance, unit type, geographic haircuts
A low rate with rigid prepay and full‑term IO can be worse than a slightly higher rate with amortization and flexibility.
Bottom line
For government‑anchored rent portfolios, DSCR‑based lending is a natural fit. But DSCR is only half of the risk story. The other half is whether the loan amortizes (reducing maturity risk) or stays interest‑only (increasing reliance on a refinance event).
If your investment thesis is built on stability, your debt structure should be built the same way.
