3 Commercial Loan Underwriting Basics You Should Know

By: Zack North

The commercial mortgage underwriting process serves a crucial purpose for lenders – in short, it helps lending institutions determine whether they should approve a loan request, and if so, what loan amount the borrower is eligible to receive.

If you’re planning to secure a commercial loan for your purchase or refinance, you can improve your level of confidence by gaining an understanding of the ins and outs of this process.

Here are 3 commercial loan underwriting basic terms to help you get started.

Loan-to-Value Ratio (LTV)

A loan-to-value ratio reveals the relationship between the requested loan amount and the value of the commercial property in question. Lenders set maximum LTVs as a way to minimize risk.

Investors or business owners who request a lower loan amount relative to the value of their property are generally able to secure a lower monthly interest rate. On the other hand, borrowers with high LTVs are generally seen as more of a risk for lenders.

In order to calculate LTV, commercial underwriters divide a property’s value by the requested loan amount. The resulting number is then converted into a percentage, or “LTV ratio.”

Traditional lenders may cap LTVs at 65-75%, though alternatives like Commercial Direct set a maximum LTV of 80% for commercial mortgage loans.

Net Operating Income (NOI)

Commercial lenders calculate NOI to determine how much income a property is likely to generate. To arrive at the NOI, underwriters subtract operating expenses from the property’s income.

When a property’s generated income is greater than its expenses, the NOI will be positive.

You should note that not all expenses are included in a NOI calculation. Some exclusions include the borrower’s income taxes and expenses related to construction or property improvement.

Why does NOI matter? While commercial underwriters don’t base their entire loan review on the NOI calculation, they do use NOI to complete a number of more advanced calculations that help tell the complete story of a property’s ability to generate sufficient revenue.

Debt Service Coverage (DSCR)

Once underwriters calculate the NOI, they can arrive at a final debt service coverage ratio (or DSCR.)

The purpose of DSCR is to help lenders determine whether or not a property generates enough income to cover its debt. To calculate DSCR, simply divide the property’s NOI by its debt service (or total debt payments).

If the resulting number is below 1, then the commercial property does not generate enough income to cover its debt. Commercial lenders generally set a minimum DSCR of 1.20 – 1.25x.

Here again Commercial Direct is able to provide a bit more flexibility for borrowers.  Our minimum DSCR for most loan programs is 1.15x.

Author: Zack North

Zack North is the Director of Marketing for Commercial Direct.  As a regular contributor to a number of top industry publications, Zack enjoys writing about topics that help investors and business owners approach commercial mortgage financing with confidence.

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