Interest Coverage Ratio (ICR) Explained

ICR is the ratio of property net income to annual interest expense at a defined interest rate. The covenant tests whether the property's income, in isolation, is large enough to comfortably service the interest cost of the loan against it. The higher the ICR, the more cushion the income provides over the interest cost — and the more comfortable the lender is with the deal.

The simple formula: ICR = Net Property Income ÷ Annual Interest Expense. An ICR of 1.30× means the property's net income is 1.30 times the loan's annual interest cost — a 30% cushion above pure breakeven. An ICR of 1.00× means net income exactly covers interest, with zero cushion (and almost no lender will lend at 1.00×).

The 1.30× bank threshold has been the standard since APRA's 2014–2018 tightening of investment property lending standards, and has not materially moved across recent rate cycles. The 5–15 bps gap between best-in-class non-bank (1.15×) and standard bank (1.30×) is one of the most material differences between the two lanes — on the same property income, a 1.15× ICR threshold supports a facility roughly 13% larger than a 1.30× threshold at the same interest rate.

The income side of ICR is the lender's assessed net property income — gross passing rent less standard adjustments (vacancy allowance, management fee, non-recoverable outgoings, sometimes capex sinking fund). The methodology is covered in detail in the guide on how banks assess commercial property income. Three points specific to ICR calculation are worth highlighting.

• Most lenders use passing rent (current contract rent), not market rent — even where market rent is higher. The exception is on imminent market-review leases where the lender may use a blend
• Some lenders apply a forward-looking adjustment for known fixed annual reviews (typically allowing the next 12 months of CPI or fixed escalation to count); others use only the current passing figure
• Personal or entity guarantor income is generally not included in the ICR calculation itself — it is a separate test under a broader serviceability assessment running in parallel

The interest side of ICR is calculated at the lender's stressed serviceability rate — not the actual paying rate. Bank stressed rate is typically the headline rate plus 3.0%; non-bank stressed rate is typically the headline rate plus 1.5–2.5%. The stress buffer is intended to test the deal's capacity to service the loan if rates move materially during the facility term.

Worked example: a deal priced at 7.50% all-in is tested at 10.50% (bank stressed) or 9.00–10.00% (non-bank stressed) for ICR calculation. On a $1.5m facility, the bank stressed interest expense is $157,500 per year; non-bank stressed interest expense is $135,000–$150,000. The same property income produces different ICR figures across the two lanes, and therefore different maximum facility sizes.

Current ICR versus stressed ICR

Some lenders distinguish between 'current ICR' (calculated at actual rate) for ongoing covenant compliance and 'stressed ICR' (calculated at headline + buffer) for initial serviceability. The covenant clause needs to specify which — sponsors who agree to a 1.30× covenant without checking whether it tests current or stressed are exposed to breach on relatively modest rate movement.

When a deal sits below the lender's ICR threshold, four structural moves can typically lift the calculation enough to bring the facility size into line with the target.

1. Reduce LVR (and therefore loan size) — the most direct lever; every 5% LVR reduction reduces interest expense proportionally and lifts ICR mechanically
2. Move from interest-only to principal-and-interest — some lenders calculate ICR on P&I commitments rather than interest only, which compresses the calculation; conversely on lenders that calculate on IO only, an IO-period structure can lift ICR temporarily
3. Strengthen the income side — verified rental receipts at higher figures than original rent roll suggested, recently signed lease renewals at new market rent, market-evidence-supported uplifts to the underlying assumption
4. Move to a lender with a lower ICR threshold — frequently the simplest answer. A deal that fails 1.30× at a major bank may comfortably satisfy 1.15× at a non-bank Full Doc lender at 75–125 bps of additional pricing

ICR is not a one-time test at facility origination — it is typically a continuing covenant tested annually (or semi-annually on larger facilities) throughout the facility term. A breach of the ICR covenant during the facility life triggers a review event with the lender, which can lead to facility repricing, additional security requirements, or in extreme cases facility default and demand for repayment.

The practical implication is that ICR needs to be monitored during the hold period, not just satisfied at settlement. Three triggers commonly cause ICR breach during the facility life: vacancy on a tenant lease expiry (income drops, interest stays), rate increases during a variable-rate facility (income stays, interest rises), and unexpected non-recoverable outgoings or capex (assessed net income drops). Sophisticated sponsors build ICR monitoring into their portfolio reporting and address marginal positions proactively rather than reactively.