Understanding underwriting can help to smooth the loan process
The underwriting process
- Underwriters decide if you and your property are a good risk.
- Their decisions are based on straightforward financial ratios.
- Complete, easy-to-understand financials help the process along.
At some point in the commercial loan process, you are going to be subjected to careful, and potentially unpleasant, scrutiny of your background, finances and business acumen. It's what's known generally as the underwriting process, in which the lenders' gatekeeper — the underwriter — decides whether it's a good idea to fund your property purchase.
It can be stressful — the lenders' representatives are necessarily judgmental, and are making decisions that you believe are essential to your financial future. It also can be a confusing process. Even if your creditworthiness and the finances of your business add up, lenders might balk because they're unfamiliar with your business niche, or feel they have already made too many loans on your type of property. So, early in the process, it's a good idea to find out who specializes in the property you're interested in financing (and who strictly avoids such property types).
But once you've determined that a lender does indeed fund the type of project you're proposing, the factors they use in their underwriting decisions are more straightforward than you might think. The emphasis on particular categories may change a bit from lender to lender, but they all are going to want some basic information about you, your property and how you intend to make money from it.
No matter what type of lender you're dealing with, your business background will factor into the underwriter's thinking. Many of the decisions are based purely on numbers, but your background and ability are more of a judgment call. Underwriters will look at the amount of experience you have in the field, your performance and — if necessary — your willingness and ability to supplement your experience with outside help.
Credit score standards
No matter how experienced you are, if you're seeking a loan from a bank, it's hard to overestimate the importance of your credit score. If your personal credit score is below 680, you'll have a hard time getting a loan that's backed by a government or government-sponsored agency, such as the Small Business Administration, Fannie Mae or Freddie Mac. Some banks might go a little lower, but not many, and not much. In addition, to your personal credit score, your business credit score — measured on a 0-to-100 scale —also likely will be considered, with a score of 75 or higher being considered an excellent mark.
If your credit isn't so good, you're not out of luck. Nonbank lenders — often the ones who advertise that they're not interested in credit history — have filled the gap left by banks that raised their lending standards during the recession. Of course, you'll usually pay higher interest rates than you would with a bank, and the underwriter will look closely at your net worth, as well as collateral in the form of equity in the property you're financing. Expect a lower loan-to-value (LTV) ratio (that is, a higher downpayment) requirement from a nonbank lender.
Unless you can show you have significant cash on hand or have a long track record with your lender, you'll be putting down at least 20 percent of the purchase price even at a bank, and probably more at a nonbank lender. The work of the underwriter is to determine that the stated value of the property is accurate, and that it and the downpayment add up to enough to compensate the lender if you default. The underwriter will, as a result, pay close attention to the appraised value of the property you're trying to finance. The results of the appraisal, not your purchase agreement, will dictate the underwriter's lending decision and the size of the loan.
Another financial comparison — the debt-service-coverage-ratio (DSCR) — becomes important when underwriters examine how you intend to use the property you're trying to buy, and it can be an unforgiving measurement. The ratio is a measure of the amount of money your property generates after expenses and taxes, compared to what it will cost to stay current on your mortgage payments. If the ratio is greater than 1.0, you're bringing in sufficient income to make your payments. If it's less than 1.0, you're not, and you'll have a difficult time persuading your underwriter to approve the loan.
The lenders use the DSCR and LTV ratios together to determine how much they're willing to lend. For instance, if at an LTV of 80 percent (that is, with a downpayment of 20 percent) your property produces less than the lenders minimum DSCR, the underwriter will reduce the loan amount, and hence debt service, to lift the DSCR ratio — which is calculated by dividing net operating income by total debt service. That means a higher downpayment in return for a more attractive DSCR.
Given the importance of the financials to a loan deal, underwriters say you'll do better in the process if you provide them with a complete picture of the property upfront. That means a current appraisal, profit-and-loss statements, rent rolls (if appropriate), occupancy certificates and applicable licenses and permits. Conversely, don't bury the underwriter with incomprehensible financial detail. Make the case for your deal with a to-the-point summary of the important details, and include a table of contents with your loan package directing the underwriter to the pertinent facts.