Lender's Little Shell Games

You know the old "Shell Game" ... where they put the pea under one of three shells and you have to keep your eye on the right one.

Let's talk a little about the Lender's shell games we are seeing a lot more of in the current cool financing climate.

These are tricks lenders will pull on you that can radically lower the amount of money they'll lend you on your next commercial purchase. Tricks you need to see coming from a long way off and be prepared to defend against.

The Loan To Value (LTV) Bait and Switch

Right now, the LTV Ratio may be the main number you use to estimate the amount of money you can get on a loan. You may say to yourself something like this, "I have a $2M purchase, and its a real bargain. The Lender says 80% LTV is no problem. I should be able to get a $1.6M loan."

Don't count on it and here's why ...

Once you are under contract and have presented your Lender Package to the Bank, the Loan to Value Ratio is absolutely and totally meaningless.

The LTV gets trumped by another ratio that is much more important to the bank.

That's your Debt Coverage Ratio (DCR).

Here's the basic formula:

Debt Coverage Ratio = Net Operating Income / Annual Loan Payment

Debt Coverage Ratio for most lenders needs to be 1.2 or higher.

This means your Net Operating Income is equal to 120% of your loan payment.

Here's where they get you...

1) The Lender will disagree on the amount of Income you can project ... and cut it.

2) They will disagree on the amount of Expenses that you will project ... and raise them.

These two changes will take a great big bite out of your Net Operating Income.

By lowering the Net Operating Income, they may drop you below the Debt Coverage Ratio that's required for that "80% LTV loan" you were counting on. They can then legitimately come back and lower the loan amount.

If you don't do something to change their thinking you only have one choice available ... bring more money to the closing table.

The Lender's thinking has nothing to do with LTV.

The negotiations will always center on your Net Operating Income. So rather than quietly give in to their little shell game of moving targets, you have to be willing to defend your projections of Income and Expenses in order to get the loan that you want.

Be ready to build your case like a lawyer.

- You may need to link arms with your Loan Broker and go back to the Lender several different times with market data to support your Income figures.

- You may have to have link arms with your Property Manager and supply information to support your Expense data.

AND remember, all this negotiation will come down in the last 10 days of the purchase process.

Be prepared to go down to the wire to get the numbers you need. And make sure your contract has a built in extension of the financing period. (take a peek at your standard purchase contract right now and check for a financing extension clause)

So when you're looking to buy your next property, start thinking like a banker.

Don't count on Loan to Value Ratios.

Be ready to defend your estimates of Income and Expense so that your Net Operating Income will support a Debt Coverage Ratio that gives you the money you need.