Most of real estate commercial lending can be boiled down to the results of three ratios:
- Loan-To-Value Ratio
- Debt Ratio
- Debt Service Coverage Ratio (DSCR)
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.
Loan to Value in Commercial Lending
The Loan-To-Value Ratio (LTVR) equals the total loan balances (1st mtg 2nd mtg 3rd mtg) divided up the fair market value (as determined by appraisal). Loan-To-Value Ratios seldom exceed 80% because the lender always want some extra protection against default.
Debt Ratio in Commercial Lending
The second ratio that commercial lending companies 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 or she earns. More precisely, the Debt Ratio equals the monthly debt obligations divided up the 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.
What is Debt Service Coverage Ratio?
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. Debt Service Coverage Ratio equals net operating income divided by debt service.
Net Operating Income
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.
Gustan Cho is a commercial lending specialist specializing in Commercial Loans and Private Lending. Gustan Cho Associates is a residential and commercial mortgage lender. Gustan Cho has been a commercial investor as well with 3,000 rental units under management.
Gustan Cho Associates also offers private lending to non-owner occupied properties throughout the United States. Private Lending is a great tool for real estate investors to utilize as short term financing or as a bridge loan. Construction private money lending is one of our specialties in private lending.