Property owners considering a commercial equity loan are often surprised by the flexibility and liquidity that these loans provide. This loan sits in second lien position (or first) behind any existing first mortgage basically eliminating the need to perform cash out refinance. However underwriting is conservative and hinges on a few main categories - combined loan to value, combined debt service coverage ratios, global income, property analysis, and credit worthiness of the borrower.

Combined LTV

Combined loan to value restrictions are capped at 70% for loan amounts between $250,001 and $500,000 or 75% for loans under $250,000. For example, on a property worth $1,000,000 with an existing loan at 40% loan to value (loan balance at $400,000) and the proposed second lien position loan would be allowed to go up an additional 30% loan to value or $300,000. The combine balance would be $700,000 or combined loan to value of 70%.

Combined DSCR

On investment properties the Combined Debt Service Coverage Ratio restrictions are set at 1:1.25. Meaning that for every $1.25 of net income (income after taxes, insurance, repairs, etc) the property produces, the combined mortgage payments cannot exceed $1.00. Said in another way, after all expenses and the mortgages have been paid, the owner needs to net $.25 to qualify.

A quirk on calculating this ratio is that underwriting will only use expenses that are reported on the borrowers Schedule E's or in the case of corporations their 8825's. The challenge with this is that most investors over state their expenses for tax benefits.

Global Income

For owner occupants a different type of ratio is used called Debt to Income Ratio aka the Global Income approach. Basically this ratio compares ALL income the borrower has, including business profit, salary dividends etc to ALL the expenses the borrower has including personal and business. The maximum Debt to Income ratio is 60%. For example, on monthly basis, if the borrower's total income is $10,000 his total monthly debt payment would not be allowed to exceed $6,000.

Property Analysis

A broad range of property types are considered. However, for buildings classified as special purpose (Assisted Living, Auto Repair, Daycare or Preschool, Gas Stations, Health Clubs, Mini Marts, Nurseries, Self Storage, Restaurants, Theaters) further loan to value restrictions apply at a combined LTV of 60%. In addition, market value and market rent is evaluated and compared to the subject property. Appearance, location, accessibility, and local market conditions, as well as other factors are considered.

Credit Worthiness

The personal credit worthiness of the borrower will be heavily scrutinized as this is a very important component. Any foreclosures or bankruptcies eliminate this loan program for the prospective borrower. A 680 credit score is the minimum for investors, while a 660 is the minimum for owner occupants. Further, interest rates are heavily dependent on the borrower's credit score. For example, the difference in rate for a borrower with a 720 vs. a 680 can be as much as 3%.

Every potential equity loan is unique and needs to be considered carefully. However, the above can give you a good idea of what the underwriting details are on a commercial equity line of credit.

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