How a private lender underwrites a mortgage: loan-to-value, cash flow and exit
Borrowers and brokers often ask what a private lender actually looks at. The honest answer is that we look at everything, but we weigh it differently than a bank. Three things carry the most weight: the value of the security, the cash flow available to service the loan and the path to repayment.
Loan-to-value
Loan-to-value is the loan amount as a percentage of the appraised value of the property. A conservative loan-to-value is the foundation of every private mortgage because it protects both the lender and the borrower if the plan takes longer than expected. We obtain an independent appraisal and we form our own view of value, including what the property would sell for in a shorter-than-ideal timeframe.
Cash flow and the sponsor
We look at whether the property or business can carry the interest, and if it cannot, how the interest will be paid. A reserve, prepaid interest or a capitalized structure can bridge a gap in cash flow. We also look at the sponsor: their experience with similar assets, their equity in the deal and how they have handled difficulty in the past.
The exit
Every bridge or term loan should have a defined exit, whether a sale, a conventional refinance or a capital event. We test the exit against realistic timelines and against a downside case. If the exit holds up under pressure, the loan is usually straightforward to approve.
This article is general information, not financial, legal or tax advice. Consult your own advisors before acting on it.
