Question

If a lender requires a maximum Loan-to-Value (LTV) ratio of 70% and a minimum Debt Service Coverage Ratio (DSCR) of 1.25, which of these two constraints determines the maximum allowable loan amount if the DSCR-calculated loan is lower than the LTV-calculated loan?

Accepted Answer

In this scenario, the DSCR constraint determines the maximum allowable loan amount. Lenders calculate the maximum loan amount using two separate metrics: the Loan-to-Value ratio and the Debt Service Coverage Ratio. The Loan-to-Value ratio limits the loan based on the property&#x27;s appraised market value, calculated as the appraised value multiplied by the maximum LTV percentage. The Debt Service Coverage Ratio limits the loan based on the property&#x27;s ability to generate income, calculated by dividing the Net Operating Income by the required DSCR to find the maximum allowable annual debt service, then solving for the loan principal that creates that payment. Because lenders must satisfy both requirements to mitigate their risk, they always select the lower of the two resulting loan amounts. If the DSCR calculation results in a lower number than the LTV calculation, it means the property&#x27;s income is insufficient to support the loan size allowed by its asset value. For example, if a property is worth 1,000,000 dollars, a 70 percent LTV would allow a 700,000 dollar loan, but if the income only supports a 600,000 dollar loan under a 1.25 DSCR, the lender will cap the loan at 600,000 dollars to ensure the borrower has enough cash flow to cover the debt payments.

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If a lender requires a maximum Loan-to-Value (LTV) ratio of 70% and a minimum Debt Service Coverage Ratio (DSCR) of 1.25, which of these two constraints determines the maximum allowable loan amount if the DSCR-calculated loan is lower than the LTV-calculated loan?

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