When applying for a commercial loan, understanding how lenders evaluate deals can significantly improve your chances of approval. In this post, we’ll walk through the four most important underwriting criteria — and how you can prepare to meet them with confidence.
1. Debt Service Coverage Ratio (DSCR)
DSCR is one of the most important metrics lenders use. It measures your property’s ability to generate enough income to cover debt payments.
Formula:
Net Operating Income (NOI) ÷ Debt Service (Principal + Interest Payments)
Most lenders want to see a DSCR of at least 1.20, meaning the property generates 20% more income than required to cover its loan obligations. A stronger ratio (like 1.5 or higher) gives you more room for unexpected vacancies or expenses — and gives the lender peace of mind.
2. Loan-to-Value Ratio (LTV)
LTV reflects how much equity you’re putting into the deal versus how much you’re borrowing. Most commercial lenders cap LTV around 75–80%, meaning you’ll need to contribute 20–25% of the property’s value as a down payment.
Example:
For a $1 million property, an 80% LTV means you can borrow $800,000 — and must contribute $200,000.
Exception:
Some SBA loans, like the SBA 504 program, allow as little as 5% down, but come with stricter terms and personal guarantees.
3. Cash-on-Cash Return (COCR)
Cash-on-cash return shows the return on the actual cash you’ve invested.
Formula:
Annual Net Cash Flow ÷ Cash Invested
Higher COCR means a more efficient use of your capital. However, putting less money down can also increase your debt burden — which may impact other ratios like DSCR. It’s a balance between risk and reward.
4. Capitalization Rate (Cap Rate)
The cap rate reflects the property’s return relative to its purchase price.
Formula:
NOI ÷ Purchase Price
A higher cap rate generally means a better deal — but also potentially more risk. Prime properties in stable markets (like Los Angeles or New York) may have lower cap rates but offer consistent occupancy and stable income. Smaller investors often prefer higher cap rates for stronger cash flow potential.
Putting It All Together: An Example
Let’s say you’re looking at a $1 million property with:
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NOI: $100,000
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Debt Service: $50,000
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Cash Invested: $200,000
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Loan Amount: $800,000
That results in:
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DSCR: 1.5 (Strong)
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LTV: 80% (Acceptable)
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COCR: 50% (Excellent)
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Cap Rate: 10% (Very Good)
From a lender’s perspective, this would be a highly favorable deal. But in the real world, deals aren’t always this clean — which is why knowing how to evaluate each criterion is crucial.
Final Thoughts
Before approaching any lender, do your own underwriting. If the numbers don’t make sense to you, they won’t make sense to them either. And if you’re unsure how to navigate these details or structure a deal creatively, working with an experienced advisor can make all the difference.
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