How to calculate the maximum loan amount a property can support

The Google robots had us down for a day or two but we are back up and running. I guess we had so many people check out the updates on Monday that it triggered their SPAM alert. Alas...they discovered I was a Human Being (their wording) and unlocked the Blog.

Anyways, I am often approached by brokers wanting to know how high their investors can push their loan amounts. The LTV of the particular program does influence the answer to this question, but not nearly as much as the NOI of the property.

SO WHAT IS MY MAXIMUM LOAN AMOUNT?

The maximum LTV most income property lenders will lend to is 80%. However, the DSCR may reduce the LTV which the property qualifies for. This discussion will describe how income property lenders arrive at the maximum amount they will lend. This is probably the most important topic in income property finance.

The key to determining the maximum loan a borrower can get is DSCR. You will remember that DSCR is defined as NOI divided by total debt service.

Also remember that total debt service includes the P&I payments on all the mortgages that will remain on the property after your new loan is arranged.

Before proceeding let us review a little basic algebra. You will recall that if we have an equality; i.e. an algebraic expression separated by an equal sign, we can multiply or divide one side of the equation by anything we want, as long as we perform the identical operation to the other side of the equal sign.

For example, let us start with the following equation:
___ 6 = 2
___ 3
If we multiply both sides by 3, the equality holds:
___ 6 = 2 x 3

Armed with this brief refresher, let’s go back and use the debt service coverage ratio (DSCR) to determine the maximum loan our borrower can qualify for. Let’s suppose that we need a 1.25 DSCR for a very attractive apartment loan. If we use the same operating statement that we used in our discussion on the DSCR in my earlier post, we will see that we have a NOI of $55,000 per year available.

Substituting the numbers we have into the DSCR equation we find:

DSCR = NOI → 1.25 = $55,000 → Debt Service = $55,000 = $44,000
___Debt service___Debt Service_______________1.25

Now you can simply work backwards to determine the maximum loan amount the property will qualify for. Let’s assume the apartment loan being quoted was at 7% with a 30 year amortization. Now using your financial calculator use 360 for N, 7% for the % rate, -$3,667 ($44,000 divided by 12) for PMT, and then solve for PV. This should give you a maximum loan amount for this property of $551,127.

Knowing how the ratios work, you should be able to see that there are two ways that the loan amount can be increased. The first is to find the programs with the lowest DSCR requirements. This can be tricky because some programs that offer a low 1.15 DSCR requirement may come up with the same maximum loan amount if they have higher default expenses that need to be utilized.

The second thing that can be done to increase loan amounts is to find ways to increase the properties NOI. This may be done through more straight forward changes such as increasing rents or decreasing the vacancy rate in the property. More complex ways to increase the NOI would involve lowering expenses. The utility expenses are always a good place to start, but property tax and insurance expenses can also be a source of saved revenue if they can be lowered.

Please let me know if you have questions about ways to maximize the loan amounts of the properties you work with.