Commercial Lending Ratios

In commercial lending, there are three important ratios used to determine whether you are qualified for the loan you are requesting. They are the Loan-to-Value (LTV) Ratio; the Debt Ratio; and the Debt Service Coverage Ratio (DSCR).

Loan-to-Value Ratio

The LTV (loan-to-value) ratio is undoubtedly the most important ratio to the underwriter of a commercial loan, who determines if your loan qualifies or not. The LTV ratio equals the sum total of all the borrower's loan balances divided by the fair market value of the property, which is usually based on the appraisal of the property. If the borrower is only applying for a first mortgage, then the numerator in the LTV ratio will be the balance of the new loan requested.

The denominator in the LTV ratio also needs further explanation. The appraisal generally is the amount used, but sometimes there is an exception when the proceeds of the mortgage loan are used to buy the same property that is securing the commercial loan. In this case, if the appraised value is less than that of the purchase price, then the commercial lender will use the lower of the purchase price or the appraisal.

Debt Ratio

Lenders use two different debt ratios to determine if the borrower can afford his obligations. The first is the top debt ratio which equals the borrower's monthly housing expense divided by his gross monthly income. The top debt ratio should not exceed 25%. Some lenders will accept a ratio of up to 28%.

The second debt ratio is the bottom debt ratio. This ratio is equal to the total housing expense plus debt payments divided by the gross monthly income. The only difference between the top and bottom debt ratios is the addition of the debt payments in the numerator. Debt payments include credit card payments, car payments, and payments on personal or installment loans. Utility payments are not included in debt payments. A bottom debt ratio should not exceed 33 1/3%, meaning the total of the borrower's housing expense and debt obligations should not exceed 1/3 of his income. Lenders may sometimes accept ratios as high as 36-40%.

Debt Service Coverage Ratio (DSCR)

The debt service coverage ratio (DSCR) is the net operating income divided by the total debt service. The ratio should be ideally over 1, meaning that the property is generating enough income to pay its debt obligations. Sometimes if the borrower has strong outside income, a lender may accept a ratio of less than one. But, in general, the higher the ratio, the more likely a borrower is to get approved for the loan.

Knowing these different ratios and how they are calculated will help you prepare for the complex commercial loan approval process.

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