The Mortgage Press is pleased to present "The Commercial Corner," a monthly column by Mike Boggiano of Silver Hill Financial LLC, dedicated to answering your questions about the commercial mortgage marketplace. If you have a question that you would like answered in a future installment of "The Commercial Corner," please e-mail [email protected].
Q: Can you explain the primary distinctions between underwriting for commercial and residential loans?
A: Most commercial lending programs focus on underwriting only the underlying property. This traditional approach is called "debt service coverage ratio" (DSCR). DSCR is calculated by taking the subject property's gross monthly rents, minus the subject property's monthly operating expenses, divided by the subject property's monthly qualifying principal and interest (P&I) payment. In addition, lead times are typically a minimum of 90 days and credit committees are often involved, making individualized deals and a non-standardized process commonplace.
By contrast, the more familiar debt-to-income (DTI) ratio used in residential underwriting quantifies a borrower's debt obligations as a percentage of his or her income. The process is more standardized and predictablenot to mention faster.
But, there's good news for residential brokers and loan originators who recognize that as rates rise, so does the need to diversify. The commercial marketplace--particularly the small-balance arena--presents considerable opportunity for residential mortgage professionals to expand their client base, product offerings and income. Fortunately, some commercial lenders are making strides in simplifying the underwriting process. One recent innovation uses a residential-style DTI qualifier, giving strong borrowers the opportunity to obtain favorable loans.
Q: How does the DTI approach work for commercial?
A: This commercial method resembles a full-doc residential program. Borrower eligibility is based on credit scores, assets, the DTI ratio, income stability and LTV. The primary benefit is that the borrower's ability to repay the loan is established by drawing upon all income sources, not just that of the property. In this respect, the process is easier for both the broker and the borrower. For example, a customer with strong credit, income and assets is interested in purchasing a property that needs renovation before it will produce cash flow. Here, the borrower could lose out on a favorable loan under the traditional DSCR method. But, if a DTI approach is applied, the borrower's financial stability allows the loan to pass, thus enabling the borrower to make a smart investment.
Q: What are the components evaluated in a commercial DTI ratio?
A: The main difference lies in taking into account the subject property's monthly P&I payment, along with the primary home's PITI (payment, interest, taxes and insurance) or rental payment. The remaining components considered are car leases, installment loans, student loans, private notes, a percentage of credit card balances and child support/alimony payments, which are similarly used in a residential loan qualification process.
Q: Does a borrower have to pass a DTI and DSCR?
A: The short answer is "no." Most commercial programs only utilize the DSCR, with ratio guidelines that differ by lender. If a program does feature a DTI approach, it's likely in order to improve the borrower's opportunity for approval. In this case, once it passes the DTI, the DSCR would be unnecessary. Minimum DTI ratios are set by the lender.
Q: What documentation is needed in a typical DCSR approach?
A: Each lender will have unique requirements, but in general, requirements include the past two years' year-to-date financial statements and tax returns. In most cases, you will also need current, fully executed leases or rent rolls (if the property type is multi-tenant retail, an office or a warehouse).
Q: How can I find out more about a commercial lender's underwriting style?
A: A phone call or visit to the company's Web site should yield this information. If not, this is a good question to ask in the initial lender interview. Colleagues are a good resource for referrals; ask around for recommendations from successful commercial brokers or residential peers who have branched out into commercial loans.
With rates steadily rising, now is a great time to diversify. Leverage your existing client base for opportunities in small-balance commercial loans, where you'll find less competition for business and a formula for success.
Mike Boggiano is senior vice president, national sales manager for Silver Hill Financial LLC. He may be reached at (877) 676-1562 or e-mail [email protected].