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 75% (sometimes
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. |