Sure, you've borrowed money before, so you know the drill, right? Actually, there are some key differences with investment property loans that make them a little bit trickier than you would expect.



When you took out your loan for your house, it was quite a whopper. It takes a quite a lot of money to buy a house, but with an investment property, you're looking at a much larger sum of money. This means that you are asking the bank to finance an incredible amount of money, and this can make success difficult.

Most of the borrowers that take out these loans are commercial businesses, not private individuals. If you want to get a large sum financed, you have to be familiar with the way commercial businesses do it. This will make you much more informed when it comes time to actually sit down with the folks at the bank. Let's look at how commercial enterprises do it.

There are three ratios commercial lenders use to calculate their expenses. These are the Debt Coverage Ratio (DCR), the Loan-To-Value Ratio (LTV) and the Debt Ratio.

You might also see the "Debt Coverage Ratio" as the "Debt Service Coverage Ratio," or DSCR, to add a little more to our alphabet soup! The idea with the DCR is to determine whether the property's income will cover its mortgage. The basic equation looks like this:

Net Operating Income (NOI) / annual debt service = the Debt Coverage Ratio.

The "annual debt service" means everything paid on the loan, including interest and principle.

The Debt Coverage Ratio should be at least 1. If it ends up lower than 1, it means that the property will not generate enough income to take care of itself. Anything under 1 is considered a percentage (with 1 being 100%). The property needs to be able to at least pay for 100% of its mortgage.

On the other hand, if you have a DCR of 1.15, this is good. This means that your venture is not only paying for itself, but also making 15% profit.

The LTV (loan-to-value ratio) is basically a ratio of the amount borrowed against either the price of the property, or its value. In most cases, this simply means the remaining balance of what you have to pay back. If you put 30% money down on a property, you will be paying the other 70% over time. This means that the LTV is 70%.

Of course, it's a little more complicated then that. Here is the equation to determine your LTV:

Loan Amount / Purchase Price = Loan-To-Value Ratio

(Purchase Price - Down Payment = Loan Amount)

This is expressed either as a percentage or a decimal figure. For our example of 30% down, we would call the LTV either 70% or 0.7.

The Debt Ratio is the simplest of all. It is the amount of debt you have compared to the amount of your assets.

Total Debt / Total Assets = Debt Ratio

With the Debt Ratio, the lower the better. If your Debt Ratio is over 1, that means that you have more debt than assets, and you are not in a very good position to receiving any type of financing. It will be tough to find a lender. If you are under 1, that means that your debts are under control, and the lower the number, the more under control your debts are.

Before heading to the bank to finance your venture, do these calculations and it will give you a better idea of where you stand. This is an important part of the decision-making process of investing in residential real estate.