Fact: Completed loan applications from banks average 10 working days. Fact: SBA provides free business counseling to all business people.
Fact: SBA has procurement assistance at small business development centers across the country. Fact: SBA does not provide lower interest rates for small business people. Interest rates are negotiable with the bank, but are limited to 2.25% above the prime rate in the Wall Street Journal for loans with maturities of less than 7 years, and limited to 2.75% with maturities of 7 years or more. Fact: SBA provides an incentive to banks to make loans of $50,000 by reducing guarantee fees by half.
Fact: SBA’s 8 (a) and 7 (j) provide specialized management and technical assistance to minorities.
Fact: SBA finance programs provide a wide spectrum of opportunities including guaranteed loans, handicapped assistance, contractor loans, veterans loans, exported revolving LOC, and small business $50,000 and less.
Fact: SBA gives veterans priority when their application arrives in the office or when they need business counseling to start a small business. Fact: SBA has no grant programs to start or expand a small business.
Fact: SBA Surety Bond Guarantee Program assist Contractors with their Bid Bond, Performance Bond, and Payment Bond.
Myth: It takes four to six months to get a SBA loan processed.
Myth: SBA provides no assistance in helping a business get federal contracts from the government. Myth: A business person can get cheaper interest rates for a business loan from SBA. Myth: Small loans are not available through SBA.
Myth: SBA has no specialized programs to assist minority persons.
Myth: There are few SBA loan programs.
Myth: SBA has no programs to assist veterans. Myth: SBA has grants to start or expand a small business. Myth: Contractors receive no assistance from SBA.
Are you and your business credit worthy?
Your personal and business ratings will be analyzed.
What kind of money do you require?
There’s short, long, intermediate term money or equity capital.
How much money do you need?
Present exactly what you need and what it is for.
Do you have sufficient collateral?
Your collateral must equal the loan amount at a minimum.
What are the lender’s rules?
Ask about loan-to-value and debt coverage ratios.
What kind of limitations will be set by you?
Know your comfort level with regard to rate, payment and term.
Lets look at the denominator, Total Debt Service.
This includes the principal and interest payments of all loans on the property, not just the first mortgage. Note that we have not included Taxes and Insurance.
They were already accounted for in part one when we arrived at net operating income (NOI). To calculate the Debt Service Coverage Ratio, simply divide the net operating income (NOI) by the mortgage payment.
For the sake of simplicity, let us assume that there is only one mortgage on the property: $500,000 First Mortgage 11% interest, 30 Year Amortized Annual Debt Payment (debt service)= $57,139 Then: DSCR= Net Operating Income (NOI)= $65,000 Total Debt Service $57,139 DSCR= 1.14 Obviously the higher the DSCR, the more net operating income is available to service the debt. From a lenders viewpoint it should be clear that they want as high a DSCR as possible. The borrower, on the other hand, wants as large a loan as possible.
The larger the loan, the higher the debt service (mortgage payments). If the net operating income stays the same and the loan size and therefore the debt service increases, then the lower the DSCR will be. Life insurance companies are very conservative and generally require a 1.25 or a 1.35 DSCR.
This means that their loan-to-value ratio are low. Savings and loan (s&l;’s) generally require a 1.20 DSCR, and sometimes will accept a DSCR as low as 1.10. A DSCR of 1.10 is called a break even cash flow. That is because the net operating income NOI is just enough to cover mortgage payments (debt service).
ADSCR less than 1.00 would be a situation where there would actually be a negative cash flow. ADSCR of say 95 would mean that there is only enough net operating income (NOI) to cover 95% of the mortgage payment.
This would mean that the borrower would have to come up with cash out of his personal budget every month to keep the project afloat.
Generally lenders frown at negative cash flow. Some lender will allow a negative cash flow if the loan-to-value is less than around 65%, the borrower has strong outside income such as being an electronic engineer, for the size of the negative is small. Lenders rarely allow negative cash flo on loans over $200,000.
The most important ratio to understand when making income property loans is the Debt Service Coverage Ratio.
It equals Net Operating Income (NOI) divided by the total debt service. To understand the ratio is first necessary to understand the numerator and the denominator. Lets take a look at net operating income (NOI) first.
Net Operating Income is the income from a rental property left over after paying all of the operating expenses: Gross schedule rent $100,000 Less 5% Vacancy Loss $5,000 Effective gross income $95,000 Less Operating Expenses Real Estate Taxes Insurance Repairs and Maintenance Utilities Management Reserves for Replacement Total Operating Expenses $30,000 Net Operating Income (NOI) $65,000 Please note that lenders always insist on some sort of vacancy factor regardless of the actual vacancy rate in order to cover collection loss.
In addition lenders insist on using a management of 3-6% of effective gross income, even if the property is owned-managed.
Their logic is that they would have to pay for management if they took back the property. Finally, note that we have not included loan payments as an operating expense. In the next article we’ll see how it all comes together as we discuss part 2.
The second ratio that lenders use to determine if a borrower can afford his-her obligations is the “Bottom” Debt Ratio.
It is defined as follows: Bottom debt ratio= (Total housing expense plus debt payments) – gross monthly income.
The difference between the two ratios is the inclusion in the numerator of “debt payments.” Debt payment include the following:
1 Car payments
2. Charge card payments
3. Payments on installment loans, for example- a washer and dryer that borrower purchased
4. 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 his “rental properties,” then the amount of the negative cash flow is usually added to the numerator of the debt ratio as if it were monthly debt obligation, like a car payment.
Traditional lending theory maintains that a borrower’s “Bottom” Debt Ratio should not exceed 33%. In other words, the total of the borrower’s housing expense and debt obligations should not exceed 1/3 of his income.
Lenders will stretch on this to add as high 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 36%.
The “top” debt ratio is defined as Top Debt Ratio= Monthly housing expense/gross monthly income by “monthly housing expense.” We mean the borrower’s monthly rent payment, or he-she owns a home, the total of the following:
1. First mortgage payment
2. Real estate taxes (annual cost-12 months)
3. Fire insurance
4. Homeowner’s home association dues “if it is a condo or townhouse”
5. Second mortgage “if any”
6. Third mortgage “if any” You will often hear the term “PITI.” It refers to the Principal, Interest, Taxes and Insurance.
While PITI is not exactly the same as monthly housing expense because it does not include homeowner’s association dues, the two terms are often used interchangeably. Lenders have learned over the years that 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 add as high as 28%. The traditional lending theory maintains that anyone with a debt ratio in excess of 25% stands a good chance of developing budget problems. Stay tuned for the explanation of the “bottom” debt ratio.
Generally the fair market value of a property is determined by an appraisal. There is one important exception,
However. When the proceeds of a mortgage loan are used to buy the same property that is securing the loan, then that mortgage is known as a “purchase money loan.” If the appraisal comes in lower than the purchase price in a “purchase money” transaction, then the lender will use the lower of the purchase price or appraisal.
Mortgage broker’s are often asked by real estate agents and buyers to base their loan on the appraised value rather than the purchase price. Their claim is that they have negotiated a super deal and that the property is worth more than what they are paying for it.
This may be so, but “generally untrue,” but lender’s also will base their maximum loan on the lower of purchase price or appraisal.
The lender’s argument is that an appraisal is really no more than an estimate of fair market value, no matter how competent or conscientious the appraiser may be. The only true indicator of value is the marketplace in which “willing buyer and willing seller,” each in full knowledge of the salient facts, neither with undue pressure, agree upon the selling terms. If the property sells for “x,” then it is probably only worth “x.”
If the borrower is only applying for a mortgage and there will be no other loan on the property, then the beginning balance of the new loan required should be inserted into the numerator.
Typically, most commercial lenders will not exceed 80% of the loan-to-value unless of course,
Central Mortgage is doing the loan.
However, if the borrower is applying for a second mortgage, then the “underwriter” (the person who determines whether or not the loan qualifies) should insert the sum of the first and second mortgages into the numerator.
Similarly, if the borrower is applying for a third mortgage, then the underwriter should insert the sum of the first, second and third mortgages into the numerator. If the borrower is applying for a second or third mortgage, the loan-to-value ratio is often known as the combined loan-to-value ratio (CLTV) ratio. In our next article we’ll look at the application of the denominator.
Unlike residential lending, commercial investment properties are viewed more conservatively. Most lender’s will require a minimum of 20% of the purchase price to be paid by the buyer.
The remaining 80% can be in a form of a mortgage provided by either a bank or mortgage company. Some commercial lender’s will require more than 20% contribution toward the purchase from the buyer.
What a bank/lender will do is subject to their appetite and quality of buyer and the property. Loan to Value is the percentage calculation of the loan amount divided by purchase price. If you know what lender’s LTV requirements are, you can also calculate loan amount by multiplying purchase price by the LTV percentage.
Keep in mind that purchase price must be supported by an appraisal. However, in the event the appraisal shows a value less than the purchase the lender will determine the loan amount on the lesser amount.
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