debt service ratio? - Posted by Burly


#1

Posted by Ed Wachsman on December 29, 1998 at 06:30:08:

“real estate lending (residential over 5 units, offices, shopping centers, etc.)” should have read "real estate lending (residential over 4 units, offices, shopping centers, etc.)


#2

debt service ratio? - Posted by Burly

Posted by Burly on December 29, 1998 at 24:59:29:

Can any one explain debt service ratio and what a quick ratio are?


#3

Re: debt service ratio? - Posted by Patrick-Ohio

Posted by Patrick-Ohio on December 29, 1998 at 17:37:00:

There are two ratios that lenders will use to qualify you for a loan amount:

Front ratio
The front ratio is your total gross monthly income (i.e. before tax) divided by your mortgage obligation (mortgage obligation consists of the principal and interest payment plus tax escrows, if required and private mortgage insurance, if required). Each lender will establish what this number should be but it typically is between 25% and 40%.

Back ratio
This ratio is your total gross monthly income divided by your mortgage obligation plus any long term debts. Long term debts are things like car loans, other mortgages, home equity loans, school loans, credit cards, alimony, and child support. This number usually should be between 33% and 45%, again depending on the lender’s policies.

Other issues to qualifying will be:

Employment history

Cash available for closing and the source of those funds

Credit history


#4

Re: debt service ratio? - Posted by Ed Wachsman

Posted by Ed Wachsman on December 29, 1998 at 05:53:13:

The quick ratio is a measure of a company’s financial health. As an accounting and investment tool it is good to understand what relationship a company’s assets have to a company’s liabilities. If liabilities exceed assets, the company is in danger of going bankrupt. Not only should a company’s assets exceed their liabilities, but they should do so by a comfortable margin. When you divide the assets by the liabilities you get a ratio which is called the Current Ratio. In many industries the benchmark for safety is considered to be a Current Ratio of at least 1.5 (for example, $1,500,000 in assets divided by $1,000,000 in liabilities). The problem is that in some industries the assets include inventories that are often listed on the books at inflated values or the inventories consist of items that are not very liquid (i.e., cannot be sold very quickly at fair market value). Therefore, banks (when considering business loan applications) and potential investors (when considering purchases of stock) also look at the quick ratio as somewhat better indication of company’s health. The Quick Ratio is the Current Assets less the Inventories divided by the Liabilities. In other words, it is the same as the Current Ratio with the value of the inventories first removed from the Assets. In many industries a Quick Ratio of 1.0 is considered the minimum safe ratio.

Ed Garcia’s reply is correct, however there is a very similar term called Debt Coverage Ratio (and some similar variations thereof) that is used as a benchmark in commercial real estate lending (residential over 5 units, offices, shopping centers, etc.). In an attempt to assure that the borrower has sufficient cash flow to cover unforeseen repairs, tenants who stop paying, etc. lenders usually require that the Net Operating Income (NOI - essentially the income less all expenses except debt service) exceed the cost of debt service by a certain amount - usually a minimum of 30%. So if net operating income after expenses is $150,000 and the principal and interest payments for all loans is $100,000 there would be a Debt Coverage Ratio of 1.50 which in most cases would be considered to be very comfortable. One of the causes of the S&L crisis of the mid-1980’s was that there were many commercial loans issued with debt coverage ratios close to 1.0 - which leaves no margin for error. If one tenant doesn’t pay, the landlord has to reach into his pocket to the pay the mortgage payment. If the pocket is empty… well you get the picture.


#5

Re: debt service ratio? - Posted by Ed Garcia

Posted by Ed Garcia on December 29, 1998 at 02:20:14:

Burly:

One of the first points I?d like to cover, is to suggest for you to go to the
How-To Articles on this web site.
There amongst other valuable information you will find Ed Wachsman?s
A Glossary Of Common Terms Used In Loans And Lending.
This will teach you terms necessary for you to know in this business.

Here is the answer to your question provided by Ed Wachsman.

DEBT RATIO (DR,D:I) Also known as debt to income. The ratio of the
total of minimum monthly debt payments to gross monthly income.
If minimum monthly payments on a credit card, auto lease, and
mortgage (PITI) were $30,$220,and $750 respectively and the gross
monthly income was $3000, the debt ratio would be 33.33%($1000/
$3000). Only debt obligations that will be in place after the loan has
funded are considered. Payments for food , utilities, entertainment,
medical bills, etc. are not included in the calculation.

Contractual obligations for rent (e.g., a lease) would be included in the
calculation. The housing ratio in this example would be 25.0%($750/
$3000).

The preferred candidate for conventional loans typically would have
debt ratios of 28% for housing and 36% for total with the maximum
ratios allowed (on a case by case basis with compensating factors; i.e.
some other strong positive to offset the negative of the higher debt ratio)
being around 30% / 40% (housing / total ). FHA and VA loans allow a
total of approximately 41%. Non-conforming loans may allow total debt
as high as 55% or so. True " hard money" loans seldom consider debt
ratios.

Ed Garcia