Why Banks Do Not Lend On Certain Loans That Appear Conservative - Part 2

Banks are not in the business of taking over property and do not want to be seen as predatory lenders. Even if a borrower has a "good story", banks would rather not even entertain a loan, which, on its surface, appears to be more likely to fall into default. Banks are very cash flow oriented. They do not want to lend to borrowers where there may be a question of how a mortgage will be serviced. In commercial real estate loans, banks use a ratio called DSCR (Debt Service Coverage Ratio). The DSCR is a measure of the cash flow available to pay current debt obligations (principal and interest in cases of a mortgage). It shows the ability to produce enough cash to cover the mortgage payment. In previous years (before 2007), most banks required a DSCR of at least 1.1.

For example, if the mortgage payment (including principal and interest) was $10,000 per month, the net cash flow (after paying normal expenses and before the mortgage) needed to be at least $11,000 per month. This was not usually an undue burden, as most real estate investors would have expected to have at least a break even cash flow after paying the mortgage. However, after 2007, almost every bank in the nation tightened up their standards to where they insisted on a DSCR of at least 1.25 and as high as 1.35. Although this may not seem excessive, the extra 15 to 25 basis point requirement severely restricted one's ability to borrow. The investor found he would have to put down a much larger down payment (thereby a lower loan needed) on the property in order to satisfy a much higher DSCR. Many real estate investors did not possess the mandated down payment and found they could not qualify for the new higher DSCR.