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MORTGAGE 101
Commercial Underwriting Basics
Commercial Underwriting Basics
Commercial loans are generally underwritten on a case by case basis.
Each 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 (DCR). 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 is 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 (LTV)
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 a
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.
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