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MORTGAGE 101
Commercial Loan Ratios
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) 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.
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 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.
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 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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