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.
