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Commercial Underwriting Guidelines
Commercial Financial is underwritten on a case by case basis. Unlike Residential Mortgage lending, commercial investment properties are viewed by some Commercial lenders as having more risk, and therefore underwritten more conservatively. Every loan application transaction 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 service coverage ratio (DSCR); this ratio is also frequently referred to as the debt coverage ratio (DCR). The DSCR is defined as the monthly mortgage debt compared to the net monthly income of the investment property in question. Using a DSCR 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. The higher the DSCR ratio, the more conservative the lender. Most commercial lenders will never go below a 1:1 ratio (a dollar of debt payment per dollar of net income generated). Anything less then a 1:1 ratio will result in negative cash flow situation, raising the risk of the loan for the lender. DSCR'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, commercial lenders are more inclined to use lower DCR's when evaluating a loan request. Make sure that you are familiar with a commercial lender's DSCR policy prior to depositing money on an application. Ask them to give you a preliminary review of the transaction, whether a purchase or refinance. Information is free, mistakes are not.
Loan to Value
Loan to Value (LTV) is the percentage calculation of the loan amount divided by purchase price. Most lenders will require a minimum of 25% of the purchase price to be paid by the buyer. The remaining 75% can be in the mortgage provided by the lender. Some commercial mortgage lenders will require more than 25% contribution towards the purchase from the buyer. What a lender will do is subject to their lending appetite, the credit of the buyer and the quality of the property. If you know what a commercial 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 independent 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. Commercial lenders will generally apply a lower LTV ratio for a refinance than for a purchase transaction.
Credit Worthiness
The credit history of the borrower(s) is a critical component of every lender’s loan evaluation; that history is a reflection of the borrower(s) commitment to meeting their obligations in a timely manner. 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 will be evaluated for a proven operating track record and quality of their credit history.
Property Analysis
The following are key components of the analysis:
- Quality, condition and age of the property
- Location and accessibility of the property
- Terms and length of the leases
- Quality of tenants
- Operating history – income and expenses
- Occupancy/vacancy ratios
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