Commercial loan underwriting guidelines can be a lot like reading Egyptian hieroglyphics to the untrained eye. One of the more confusing facets of commercial lending when compared to consumer lending. The key is to understand the difference between DTI, better known as “Debt to Income Ratio” and DSCR, which stands for “Debt Service Coverage Ratio”.
The two terms sound confusing, but in reality they are simply mirror images of one another. DTI is calculated by dividing the annualized debt payments of a borrower by the borrower’s annual gross income. The lower the score, the better with most lenders seeking those ratios to be at or below 45%. The debt payments would include the payment of the new proposed loan, real estate taxes, association fees, other real estate mortgage payments, taxes, and fees, minimum credit card payments (not the amount you actually make as a payment…just the required minimums), car payments, student loan debt, and other installment of revolving credit payments. DTI does not typically include utility payments, grocery bills, gasoline costs, etc. DTI is typically only used in consumer transactions.
DSCR, however, is the measurement used in commercial lending to calculate a borrower’s debt load. It is simply the DTI calculation flipped on its head. With DSCR, you would divide the borrower’s annualized income by their annualized debt payments…just the opposite of the DTI Calculation. Unlike with DTI, the higher the Debt Service Coverage Ratio the better. Most lenders have a minimum DSCR of 1.25X with most requiring a higher DSCR.
Borrowing commercially can be somewhat confusing to many, but it really is quite simple. If you just remember that, although they essentially calculate the same thing…the borrower’s ability to make payments, they are simply inverse calculations of one another