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) is defined as follows:
Loan-To-Value= Total loan balances (1st mtg+2nd mtg+3rd mtg) /
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 earns. More precisely, the Debt Ratio is defined as:
Debt Ratio = Monthly Debt Obligations / 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. It is defined as:
Debt Service Coverage Ratio = Net Operating Income / 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.
