5 Things Lenders Look For in a Borrower

Brokers and borrowers alike often view lenders as faceless institutions obligated to loan money to anybody,
no matter how risky the transaction. As anyone who has tried to procure a commercial mortgage loan lately
knows, however, lenders have been nothing less than cherry-pickers since the economic downturn, choosing
to lend only to high net-worth individuals or institutions on stabilized Class-A and Class-B properties.

In this lending atmosphere, commercial mortgage brokers can help their clients increase their chances of
securing financing — not only by finding the right lender for the deal but also by making sure their clients
possess all the components of a creditworthy borrower.

When approaching a deal, brokers should first try to put themselves in the lenders’ shoes. Think of the lender
as a partner who has just as much to risk as the borrower. In fact, in many cases lenders are investing three
times the amount of money as the borrower, so they want to be certain they are entrusting their money to a
competent — and creditworthy — partner.

It’s critical that brokers prequalify their clients to identify potential weak links that may cause a lender to
reject the deal. Brokers often focus solely on the property’s quality and cash flow but fail to identify potential
sponsorship issues that a lender will find unacceptable.

There are five components of a creditworthy borrower that every broker must clearly demonstrate to the
lender:

1. Net worth
2. Liquidity
3. Free cash flow
4. Credit score and history
5. Ownership experience

Presenting these five components in the most favorable and positive manner may be the difference between
securing a loan and walking away empty-handed.

Net worth
To start, lenders must know the borrower’s net worth. Simply subtracting the liabilities from the assets
doesn’t necessarily translate into a trustworthy estimate, however. Lenders will question asset values when
borrowers don’t provide supporting documentation to back up the market values assigned to each one.
Conversely, borrowers rarely overstate their liabilities but instead tend to understate them. An overstatement
of assets and an understatement of liabilities can result in an erroneous net worth.

A broker usually can find borrowers’ net worth on their personal financial statements. A personal financial
statement includes a balance sheet and an income statement with supporting schedules that provide details for
the values stated on the primary balance sheet. Borrowers rarely provide adequate details for a lender to
discern whether the value of the assets is realistic or if the equity in the assets is market equity, actual cash
equity or both.

Lenders want to make quick decisions. Omitting critical financial information is a sure way to lose a lender’s
interest. To keep a lender interested, prequalify borrowers by scrutinizing their personal financial statements.
Call them and get details, ask questions and make sure the schedules are self-explanatory. As a general rule, a
borrower’s net worth must be equal to or greater than the requested loan amount.

Liquidity
The term liquidity is often misunderstood and is many borrowers’ primary shortcoming, thus the primary
reason that lenders decline many loan requests. Generally speaking, liquidity is defined as any asset that can
be liquidated or converted into cash, usually within three days. Liquid assets include cash, stocks and bonds,
or any marketable security.

Brokers also should think in terms of pre-funding and post-funding liquidity. Pre-funding liquidity refers to
all the cash available for the down payment, operating capital and capital improvements or replacements. The
only way to determine if the pre-funding liquidity is adequate is to prepare a “Sources and Uses of Funds”
schedule.

Post-funding liquidity is important because lenders like to see a surplus of cash after closing so borrowers
have adequate reserves for items such as capital replacements, immediate repairs, renovations, working
capital and deductibles for insurance claims.

In general, the degree of liquidity must equal at least 10 percent of the loan amount or about 12 months’
worth of debt service.

Free cash flow

A personal financial statement includes a balance sheet and income statement or statement of cash flow. The
statement of cash flow is rarely completed accurately, if completed at all. Borrowers may have many sources
of income, such as a W-2 salary, business investments and real estate investments. All of these must be taken
into account when determining their cash flow.

Free cash flow is the cash available after all operational expenses, mortgage and debt payments and federal
income taxes. It is the amount left for borrowers to use however they like. Calculating borrowers’ free cash
flow helps determine how much they have available to contribute to any particular mortgage payment in the
event of a disruption in cash flow at the property level. If borrowers do not have enough free cash flow, then
they more likely will fall behind on mortgage payments or default if the property experiences a disruption in
cash flow.

One of lenders’ biggest challenges is getting their arms around borrowers’ personal cash flow. Brokers can
add tremendous value by helping their clients construct their personal cash-flow statement. This may seem
like tedious, time-consuming work, but the alternative is a nebulous personal cash-flow statement that raises
more questions than it answers.

If you can’t fully grasp or interpret a borrower’s free cash flow, then the lender likely can’t either — which
means no loan.

Credit score and history

The fourth component of creditworthy borrowers is their credit. A borrower’s credit score may seem self-
explanatory, but do not make any presumptions in this area. If possible, review all their credit reports from
the three primary credit-reporting agencies and identify any derogatory credit marks, such as late payments,
collections, high balances, too many credit cards, unsecured debts, too many auto loans, etc., as well as
public records like bankruptcies, tax liens or summary judgments.
Any credit issues or potential blemishes need written explanations and most likely should be resolved before
the lender sees these reports. If lenders discover any derogatory marks on a credit report, it is sure to spook
them. A broker can pre-empt the lender by reviewing the credit reports first, thus providing explanations as
needed and eliminating any suspicion. Even if the issue can be resolved or if there is a good explanation for
the derogatory mark, you never want the lender to get a negative first impression.

Ownership experience
Another area that borrowers often fail to demonstrate adequately is their previous ownership experience. This
may not be monetary in nature like a balance sheet, but it does reflect their ability to manage financial affairs.
Not only must borrowers show a high net worth, adequate liquidity and strong credit scores, but they also
must convince the lender that they are capable of making sound business decisions and managing money and
personnel. 

Borrowers usually can demonstrate ownership experience with a professional résumé, but that document
often pertains only to education and past employers. Lenders really are looking for borrowers’ history and
experience in owning and operating commercial real estate, such as apartments, retail centers and office
buildings.

Managing commercial properties for others, whether as an employee or independently, is a good start, but
some lenders don’t equate that type of experience with actual ownership.

Presenting the borrower

Brokers can facilitate the process of determining a creditworthy borrower by using four financial documents
that are critical for lenders’ credit evaluations:

1. Personal financial statement

2. Personal cash-flow statement
3. Schedule of real estate owned
4. References
There are many versions of a personal financial statement created by banks floating around the public
domain. Whichever one you use, be sure that it includes separate schedules to support the values shown on
the main balance sheet.

The personal cash-flow statement is harder to find. Most personal financial statements include a section for a
list of income and expenses, but it’s hardly useful because of the limited amount of space available to write
in. It’s best to use a completely separate form that has plenty of room to be detailed as possible.

The third and most important document is the schedule of real estate owned, which lists all of the borrower’s
residential and commercial properties. This document is the one that lenders scrutinize the most. It is
essentially a supplement to the balance sheet for all the real estate assets. This document also details the
source of all personal cash flow generated from real estate investments.

The last financial document is a list of banking and credit references that show the lender that the borrowers
are in good standing with current mortgage lenders and have a history of fulfilling their mortgage obligations.

Commercial mortgage brokers must prepare their clients’ deals with today’s lending criteria in mind.
Although the property’s fundamentals are still important, a borrower’s net worth, liquidity, free cash flow,
credit history and experience play a critical role in determining whether a lender will fund the deal. By
carefully reviewing and preparing clients’ financial statements, brokers can position their deals for success.