Underwriting7 min read
Three tests size your loan. Only one of them is binding
LTV, debt service coverage and debt yield are computed independently, and the smallest answer wins. Knowing which one bound tells you exactly what to fix.
Ask three lenders how large a loan a building supports and you will get three answers, but every one of them will have been produced the same way: by running three tests and taking the smallest result.
Loan to value
The loan divided by the lower of purchase price and appraised value. It is a collateral test, and it is the one borrowers understand. It is also the least informative of the three, because it says nothing about whether the building produces enough income to pay the loan.
Debt service coverage
Net operating income divided by annual debt service. A 1.25× minimum means the property must produce twenty-five percent more income than the loan costs. Crucially, most lenders test coverage at a stressed rate above the note rate, so the loan you are quoted is often sized against a rate you are not paying.
Debt yield
Net operating income divided by the loan amount. It ignores rate, amortisation and appraised value entirely, which is exactly why lenders trust it. A nine percent debt yield floor asks one question: if we owned this building tomorrow, what unlevered return would our loan basis earn?
Debt yield does not move when rates move. That is why it binds in exactly the markets where the other two tests flatter a deal.
What the binding constraint tells you
- LTV binding means the income is fine and the price is the problem. Negotiate the price or bring more equity.
- DSCR binding means the rate or the amortisation is the problem. A longer schedule or a rate buy-down moves the answer; more equity does not, dollar for dollar.
- Debt yield binding means the income itself is too thin for the basis. Nothing structural fixes that — only more NOI or a smaller loan does.
A worked example
| Test | Assumption | Loan supported |
|---|---|---|
| LTV | 70% of $1,450,000 | $1,015,000 |
| DSCR | $118,000 NOI at 1.25× on a 25-year, 6.75% constant | $1,046,000 |
| Debt yield | $118,000 NOI at a 10% floor | $1,180,000 |
That last sentence is the whole point. The binding constraint is not a property of the building; it is a property of the building, the rate, the schedule and the lender’s floors taken together. Change any one of them and the answer can move to a different test — which is why a sizing conversation that ends at a single number has skipped the useful part.
Our sizing calculator prints all three, names the one that binds, and shows the gap to the next constraint. That gap is the negotiating room.