Loan to Value Ratios & DSCR’s
Loan to Value Ratio (LTV)
Loan-to-value ratio (LTV) is the amount of the mortgage loan compared to the value of the property. This ratio is calculated by the lender prior to providing a mortgage. The results of this calculation help to determine whether or not the applicant will qualify for a loan and whether the application, if approved, will be for a conventional loan or a high ratio loan.
Here is an example. Assume:
Property Value = $1,660,000
Down Payment = $415,000
In this case the LTV = 75%
The calculation used is simple: 1 – (down payment / property value)
Or in our example: 1 – ($415,000 / $1,660,000)
Most lenders when lending on Commercial Real Estate assets in Winnipeg, require an LTV of between 65% & 75%. The range fluctuates primarily on the asset type being borrowed against & borrower strength.
Debt Service Coverage Ration (DSCR)
The DSCR or debt service coverage ratio is the relationship of property’s annual net operation income (NOI) to its annual mortgage debt service (principal and interest payments). Using the example above, if the property has $125,000 in NOI and $106,400 in annual mortgage debt service, the DSCR is 1.175. Most lenders will require a minimum DSCR of 1.20 or higher.
Commercial lenders use the DSCR to analyze how large of a commercial loan can be supported by the ash flow generated from the property, or to determine how much income coverage there is at a certain loan amount.
Two of the most important factors used to determine the approvability of a commercial mortgage requests are the DSCR and loan-to-value (LTV). Often times, as in the example above, the load amount may be debt service constrained and the maximum LTV not obtainable.
Using the above example, if the maximum LTV is 75% and the DSCR is less than the lender’s required minimum coverage requirements at 75% LTV, the loan amount will be reduced until the minimum DSCR is obtained. In commercial underwriting it’s not uncommon for a property with a low cap rate to require a higher down payment (say 35% for a 65% LTV) in order to maintain a lender’s required minimum DSCR.
DSCR = NOI / Annual Debt Service
To calculate the debt service coverage ratio, simply divide the net operating income (NOI) by the annual debt payment.
Commercial Loan Size: $1,330,000
Interest Rate: 6.0%
Term: 20 Years
Annual Payments (Debt Service) = $113,636
Net Operating Income (NOI) = $125,000
Now we can calculate the DSCR:
DSCR = Net Operating Income / Annual Debt Service
(NOI) = $125,000
Total Debt Service = $113,636
DSCR = 1.175 ($125,000 / $113,636)
What this example tells us is that the cash flow generated by the property will cover the new commercial loan payment by 1.175x. This is generally lower than most commercial mortgage lenders require, so the loan amount will be reduced & the borrower will be asked to put more cash down.