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Finally, both fixed- and adjustable-rate mortgages are available on the market. Fixed-rate loans, however, dominate the commercial-mortgage market. Interest rates are expressed as a basis-point “spread” added to an index (often a U.S. Treasury), which bears a term corresponding to the loan term. A 10-year loan is priced over the 10-Year U.S. Treasury Security issue.
The spread charged on the loan is determined primarily by the loan-to-value (LTV) and debt-service-coverage ratio (DSCR). A property with a greater LTV and lower DSCR is riskier to the lender; therefore, the borrower will be charged a higher interest rate.
So how does a real-estate lender determine the amount it will lend on a property? The two most-important indicators of credit quality of the collateral securing the loan are DSCR and LTV. The primary indicator is the DSCR (net-operating income divided by mortgage payment). LTV is less reliable because the value of the property will change significantly depending on the cap rate used (the discounting term for the property’s cash flows).
Required LTVs and DSCRs vary for different property types and from lender to lender. General industry standards are a maximum 80 percent LTV and a minimum 1.25 times the DSCR; the net operating income must be at least 125 percent of the mortgage payment. It is important to note that on acquisition loans, the lender will be constrained by the lower of loan-to-value or loan-to-cost, assuming the loan is not DSCR-constrained.
Borrowers commonly request that the property be appraised for a higher value than what they are paying for it. “Give me 80 percent of the appraised value,” they say. Lenders generally respond, “Congratulations on your shrewd negotiating skills. You still have to put 20 percent cash in the deal.”
Financing is a critical element to the long-term economic success of a property. With research and diligence, a program suited to borrowers’ needs and the needs of their real-estate assets can be found. For the term of the loan, reputable lenders treat borrowers as partners, not as adversaries.
In today’s market, competition among lenders is fierce, which is good news for borrowers. Rates also still are so far below historical levels that it is simply staggering — more good news.
But remember, as the saying goes, “All good things come to an end.”
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