Commercial Financing
is underwritten on a
case by case basis.
Every loan
application is
unique and evaluated
on its own merits,
but there are a few
common criteria
lenders look for in
commercial loan
packages.
Financial Analysis
A key
component in making
an underwriting
evaluation is the
debt coverage ratio.
The DCR is defined
as the monthly debt
compared to the net
monthly income of
the investment
property in
question. Using a
DCR of 1:1.10 a
lender is saying
that they are
looking for a $1.10
in net income for
each $1.00 mortgage
payment. Typically
they will determine
the DCR ratio based
on monthly figures,
the monthly mortgage
payment compared to
the monthly net
income. The higher
the DCR ratio the
more conservative
the lender. Most
lenders will never
go below a 1:1 ratio
( a dollar of debt
payment per dollar
of income
generated). Anything
less then a 1:1
ratio will result in
a negative cash flow
situation raising
the risk of the loan
for the lender.
DCR's are set by
property type and
what a lender
perceives the risk
to be. Today,
apartment properties
are considered to be
the least risky
category of
investment lending.
As such, lenders are
more inclined to use
smaller DCR's when
evaluating a loan
request. Make sure
that you are
familiar with a
lender's DCR policy
prior to spending
money on an
application. Ask
them to give you a
preliminary review
of the investment
property that you
want to purchase.
Information is free,
mistakes are not.
Loan to Value
Unlike residential
lending, commercial
investment
properties are
viewed more
conservatively. Most
lenders will require
a minimum of 20% of
the purchase price
to be paid by the
buyer. The remaining
80% can be in the
form of a mortgage
provided by either
bank or mortgage
company. Some
commercial mortgage
lenders will require
more than 20%
contribution towards
the purchase from
the buyer. What a
bank/lender will do
is subject to their
appetite and the
quality of the buyer
and the property.
Loan to value is the
percentage
calculation of the
loan amount divided
by purchase price.
If you know what a
lender's LTV
requirements are,
you can also
calculate the loan
amount by
multiplying the
purchase price by
the LTV percentage.
Keep in mind that
the purchase price
must also be
supported by an
appraisal. In the
event that the
appraisal shows a
value less then the
purchase price, the
lender will use the
lower of the two
numbers to determine
the loan that will
be made.
Credit Worthiness
For
businesses less than
three years old,
personal credit of
principals will be
evaluated. This may
hold true for longer
periods of time for
tightly held
companies. For
corporations,
business performance
and credit ratings
will be evaluated
with a proven track
record.
Property Analysis
Fair
Market Value and
Fair Market Rent
will be analyzed.
Special use property
may require
additional
underwriting. Age,
appearance, local
market, location,
and accessibility
are some other
factors considered.
Commercial Lending
Ratios
Most
of real estate
lending can be
boiled down to the
results of three
ratios:
The
bulk of the energy
spent "processing" a
loan is merely an
attempt to verify
the numbers that go
into the numerator
and denominator of
the above 3 ratios.
The
Loan-To-Value Ratio
(LTVR) is defined as
follows:
Loan-To-Value= Total
loan balances (1st
mtg+2nd mtg+3rd mtg)
/ Fair market value
(as determined by
appraisal)
Loan-To-Value Ratios
seldom exceed 80%
because the lender
always want some
extra protection
against default.
The
second ratio that
lenders use when
underwriting a loan
is the Debt Ratio.
The Debt Ratio
compares the amount
of bills that the
borrower must pay
each month to the
amount of monthly
income he earns.
More precisely, the
Debt Ratio is
defined as:
Debt Ratio = Monthly
Debt Obligations /
Monthly Income
Obviously someone
whose Debt Ratio is
150% is in trouble.
A Debt Ratio of 150%
would mean that a
borrower's
obligations are one
and a half times his
income. Debt Ratios
seldom are allowed
to exceed 40% in
practice.
The
final ratio used in
lending is the Debt
Service Coverage
Ratio (DSCR). The
Debt Service
Coverage Ratio is a
sophisticated ratio
only used for large
loans on income
producing
properties. It is
defined as:
Debt Service
Coverage Ratio = Net
Operating Income /
Debt Service
Net
Operating Income is
the income from a
rental property
after deducting for
real estate taxes,
fire insurance,
repairs, and all
other operating
expenses; and Debt
Service is the
mortgage payment on
the property. Most
lenders insist that
this ratio exceed
1.0. A debt service
coverage ratio of
less than 1.0 would
mean that the
property did not
produce enough net
rental income for
the owner to make
the mortgage
payments without
supplementing the
property from his
personal budget.
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