It will be an advantage for prospective buyers of commercial properties to understand the process of commercial mortgage underwriting.
Knowledge of commercial mortgage underwriting helps if you intend to obtain debt financing for commercial assets. Lenders explain to borrowers existing interest rates; internal loan policies for underwriting rations; loan-to-value and debt-service coverage percentages; and, likely lender modifications to Net Operating Income. This takes place prior to complete underwriting and credit approval procedures.
Basics of Mortgage Underwriting
Commercial mortgage underwriting used to be made depending on the bank or insurance firm’s guidelines and internal credit policies. It is done based on individual merits. After this, the lender reviews the borrower’s portfolio and decides on the market saturation point of the property along with delinquencies. This will be the final basis for approval or denial of the loan.
It frequently happens that prospective borrowers comply with credit policies only to find out that their applications were disapproved. The probable reason is lenders could have seen high delinquency rates for said categories of properties. Fortunately for mortgage applicants, more funding options are now available for these kind of loans.
Analysis of Cash Flow
In commercial mortgage underwriting, the most essential step is the property’s cash flow assessment. It needs sufficient cash flow to cover expenditures along with mortgage payments. The Debt Service Coverage Ratio (DSCR) is used to compute this cash flow. The general rule is lending companies require at least 1.20 X DSCR or $1.20 contribution in cash flow for every $1 worth of debt incurred to sustain payments.
Commercial real estate loans are scrutinized more strictly compared to residential mortgages. In fact, commercial banks generally demand a minimum 20 percent in purchase price to be paid when the buyer applies for a commercial mortgage. The balance of 80 percent will be in the form of credit coming from the lending facility or bank. Some credit firms even ask for over 20 percent as purchase contribution.
The Loan-to-Value represents the percentage computation of the mortgage (commercial properties) divide by the purchase cost. It is possible to compute the mortgage amount means of multiplying purchase price by the loan-to-value percentage if you know the lending company’s requirements for LTV. The purchase price also needs an assessment. In case the appraisal reveals a value lower than the purchase cost, lenders use the lower figure to establish the mortgage amount.
Personal credits of principals are appraised with regards to commercial mortgages for commercial properties occupied by business owners or companies with less than three years of operations. On the other hand, the single-purpose entity bankruptcy remote is formed to take over for businesses occupied by non-owners. Guarantors are not required to submit personal financial statements or income tax returns in the case of commercial mortgages with stated incomes.
Commercial mortgage underwriting is a complicated matter that calls for careful examination. Borrowers need to focus their attention on details during the process. Otherwise, lack of foresight can lead to problems in the future.