Commercial Real Estate

The Commercial Loan Evaluation Process

Discover how the commercial loan evaluation process works and learn what the lender looks at when deciding whether to lend or not.


Introduction
The process of evaluating a loan application is known as underwriting. It involves analyzing the borrower’s financial history, credit score, income, and assets to determine if they're qualified for a particular loan.
 
Underwriting
Once you have been approved for a commercial loan, your commercial lender will need to perform underwriting. Underwriting is the process of evaluating a borrower to determine if they are creditworthy and will be able to repay the loan.
 
Underwriting involves several key steps:
  • Analyzing the business plan and balance sheet, as well as confirming that financial statements are accurate and in order
  • Reviewing market conditions that may affect your business's cash flow or collateral value
  • Confirming that collateral is sufficient and secure (e.g., reviewing property deeds)
Below are some of the ratio’s that your lender will consider when evaluating your loan.
 
LTV Ratio
As you know, the Loan-to-Value ratio is the amount of a loan compared to the value of the commercial property. The higher this ratio, the more secure it is for you as a borrower. If a lender thinks that there's less risk involved in lending you money because your LTV ratio is high, they will be more willing to lend you money at a lower interest rate.
 
If this were not the case, lenders would have no choice but to charge borrowers an exorbitant amount of interest and fees because they couldn't be sure if they would get their money back or not; after all, who wants their business model based on uncertainty?
 
DSCR
DSCR is a measure of how much of the monthly payment is going towards the interest portion of the loan. DSCR is calculated by dividing the loan amount by the monthly payment. A high DSCR indicates that more of your payment goes towards interest, which means you are at a higher risk of defaulting on or prepaying your loans.
A good rule-of-thumb for calculating DSCR on your own is to take an average annual percentage rate (APR) for similar loans and multiply it by 12 to get what most lenders will consider an acceptable number. For example, if you were borrowing $100,000 at 4%, then taking 4% times 12 would give us 48%. If we divide 100,000 by this number we get 0.48 (or 48%). This means that slightly more than half ($0.48) of our payments are going towards paying off principal rather than just covering interest charges each month!
 
DTI Ratio
The debt to income ratio is one of the most important factors when evaluating a borrower's ability to repay. It measures how much debt you can afford and is calculated by dividing your monthly debt payments (including credit card payments and car loans) by your gross income.
 
The maximum rate for conventional loans varies from lender to lender, but in general, lenders will expect a DTI below 50%, with some going as low as 43%. If your DTI ratio exceeds these percentages, it's likely that you won't be approved for the loan.
 
Conclusion
When you’re looking for a loan, it can be difficult to know how much money you’ll get and what you need to provide in order to qualify. The process is complex and may seem overwhelming if you don’t have experience with loans or financial planning. But there are things that will make your application more likely to succeed—and one of those is getting an evaluation from a lender before submitting it.
 

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