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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   January 2006

Learn the Good from the Bad

Assess your borrowers’ credit, income and collateral to determine the loan’s fundability

If you follow the credit, income and collateral (CIC) rule of thumb when sourcing for commercial-loan candidates, you usually can’t go wrong. The information you find by assessing your clients’ CIC allows you to distinguish the good from the bad. What’s more, the information can be gathered in very little time. Putting in the effort to review this data can prevent you from wasting valuable time with deals that may never fund.

The first component of CIC is the credit or FICO score. FICO scores range from 300 to 850 — with 300 being the worst and 850 the best. Most lenders use a credit-score report called a tri-merge to determine a borrower’s credit grade. The tri-merge is a report from the three major credit-reporting agencies — TransUnion, Experian and Equifax. Typically lenders will look at the median FICO score (the mid-FICO) to grade a loan. The mid-FICO often determines the borrowers’ loan to value (LTV), the loan terms available, the interest rate and whether or not the loan will be approved. Just a few points difference in a credit score can change a deal dramatically. For example, consider this typical grading system:

  • A+ (700 and above): This pristine credit results in the most competitive rates, LTVs as high as 90 percent and 30-year terms.
  • A (680 to 700): Solid rates; LTVs at 80 to 90 percent; 30-year terms available
  • A- (640 to 680): Fair rates; LTVs 70 to 80 percent; terms sometimes reduced to 20 to 25 years
  • B (600 to 640): B rates; LTVs 60 to 70 percent; terms can be reduced to 15 years (At this level, credit is analyzed very carefully and mortgage history becomes vital.)
  • C (600 and below): Often unfundable; double-digit rates common; LTVs 60 percent and below, terms as short as 12 to 36 months

Be careful when analyzing a deal based on credit though. Anomalies can occur. For example, your borrowers could have a 700 mid-FICO score, but also have two late payments in their mortgage history. Even though they meet the lender’s rate guidelines, the late mortgages will significantly affect an underwriter’s decision.

The second component in the CIC is the income analysis. Income can come from the property  and/or the borrowers’ own income. Most lenders look at both. Lenders seek to fund loans in which the borrowers can pay the loan payment with some cash in reserve. A good rule is that the debt-service-coverage ratio (DSCR) should be at least 1.2 for multifamily properties and more than 1.25 for all other property types. When a property such as a multifamily building has a strong rental income, personal income becomes less important. For owner-occupied properties such as auto-repair shops, personal income becomes a deciding factor in approving the loan because the property itself doesn’t generate income; the business does.

Debt-to-income ratio (DTI) is also analyzed. A general lender requirement is a 55 percent DTI for non-owner-occupied properties and 80 percent DTI if it is owner-occupied. An adjustment for assets would make it 45 percent for investor properties and 65 percent for owner-occupied properties. This means that before adjustment for liquidity, the DTI could be 60 percent and 80 percent, respectively.  

With stated-income, stated-asset (SISA) loans, lenders do not look at personal income. However, the property’s income is still disclosed in the appraisal and so it must provide debt service for the loan to work. Lenders often are more lenient and will allow the loan to fund even at a .8 DSCR. This means that the property is at a 20 percent annual loss on paper. So why would borrowers want to buy such a property? Because they believe the property was mismanaged and plan to change that by raising the rents, reducing expenses and having a solid cash flow. SISA loans are offered based on good credit scores and solid property types. As such, rates will generally be higher and LTVs lower.

The final component in the CIC is the collateral. Collateral for the majority of commercial loans is the property only. Typically only the Small Business Association or select banks will view additional types of collateral such as equipment or inventory.  Collateral, similar to the credit score, can help determine LTV, rates and terms. The best and most-desired property types for collateral are multifamily, retail and office. The least-desired properties are special-purpose or single-use properties such as carwashes, hotels, motels and restaurants. In fact, restaurants rate right up there with nuclear power plants due to their high failure rates.

 Lenders typically use the tier system to assess the risk of the property. Tier 1 properties are the least risky, tier 4 the most. Multifamily and mixed-use properties are in Tier 1. Retail, office, warehouse and self-storage properties are in Tier 2. In Tier 3 are rooming houses, bed and breakfasts, campgrounds and car washes. Restaurants, hotels, motels, daycares and funeral homes are in Tier 4.

Keep in mind each lender has its niche. Some love mobile home parks, while others love auto repair. Some like neither. Find your lender’s sweet spot.

Again the CIC rule of thumb can expedite your qualification process and ultimately save you valuable time. This kind of good time management leads to a healthy bottom line. 


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