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Underwriting Guidelines
Commercial Lending Ratios
Commercial LTV
Ratio
Commercial
Debt Ratios
Questions to
Ask Yourself
Commercial Loan
Checklist
Commercial Financing
Options
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Commercial Debt
Ratios
When
analyzing the personal budget of a borrower,
lenders use two different debt ratios to determine
if the borrower can afford his obligations. These
two debt ratios are:
1.
Top Debt Ratio
2.
Bottom Debt Ratio
The "top" debt ratio is
defined as:
Top Debt Ratio = Monthly Housing
Expense/Gross Monthly Income
By "monthly
housing expense" we mean either the borrower's
monthly rent payments, or if she owns her own
home, the total of the following -
Monthly
Housing Expense
. 1st
mortgage payment on home plus
. Real estate
taxes (annual cost/12) plus
. Fire insurance
(annual cost/12) plus
. Homeowner's
association dues(if home is a condo or townhouse)
plus
. Second
mortgage payment (if any) plus
. Third mortgage
payment (if any).
You will often hear the
term P.I.T.I. It refers to (P)rincipal,
(I)nterest, (T)axes and (I)nsurance. While
P.I.T.I. is not exactly the same as Monthly
Housing Expense because it does not include
homeowner's association dues, the two terms are
often used interchangably.
Lenders have
learned over the years that a borrower's "top"
debt ratio should not exceed 25%. In other words,
a person's housing expense should not exceed 1/4
of his income. While lenders will often stretch
this number to as high as 28%, traditional lending
theory maintains that anyone with a debt ratio in
excess of 25% stands a good chance of developing
budget problems.
The second ratio that
lenders use to determine if a borrower can afford
her obligations is the "bottom" debt ratio. It is
defined as follows:
Bottom Debt Ratio = (Total
Housing Expense + Debt Payments)/Gross Monthly
Income
The only difference between the two
ratios is the inclusion in the numerator of "debt
payments." Debt payments include the following:
Debt Payments
. Car payments
. Charge card payments
. Payments on installment loans,
for example - a payment on a washer &
dryer that the
borrower purchased.
. Payments on
personal loans, for example - a signature loan
from the borrower's
bank.
What is not included in "debt
payments" is Utilities such as PG&E, water or
telephone and payments on real estate loans. Real
estate loans are usually offset first by the net
rental income from the property. If the borrower
has a net positive cash flow from all his rentals,
then the net income is usually added to his "gross
monthly income." If the borrower has a net
negative cash flow from all of his rental
properties, then the amount of the negative cash
flow is usually added to the numerator of the
"bottom" debt ratio as if it were a monthly debt
obligation, like a car payment.
Traditional lending theory maintains
that a borrower's "bottom" debt ratio should not
exceed 33 1/3%. In other words, the total of the
borrower's housing expense and debt obligations
should not exceed 1/3 of his income. Lenders often
will stretch on this ratio to as high as 36%, and
some have even been known to stretch as high as
40% or more. Obviously a loan with a debt ratio of
40% is a far more risky loan than a loan with a
debt ratio of 32%. |
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