A building is appraised and purchased at £6m will create a £500,000 NOI in Y1. The bank lends at 10% interst only and has specified a maximumum LTV of 75% and DSCR of 1.25
What is the maximum loan?
I am trying to follow a solution but getting stuck.
The LTV = 75% x 6m = 4.5m
I thiought this would be final answer, but now we have to incorporate the DSCR?
DSCR = NOI/debt service … rearrange we hget 500K/1.25 = 400k (max debt service). However, the final answer suggests the correct answer is maximum loan is 4m taking into account 10% interest. Can someone clarify this please?
Apparently, they’re assuming that it’s an interest-only loan.
Nevertheless, if it’s an interest-only loan, then the maximum debt service of £400,000 corresponds to a maximum loan amount of:
£400,000 / 10% = £4,000,000
That’s less than the maximum loan value based on the LTV, so that’s that.
(Note: if the question writer had done his job properly, he’d have made the loan amortizing: you’d have had to have calculated the present value of an amortizing loan with a £400,000 payment (PMT) and used that.)
in the question - they said --> The bank lends at 10% interst only -> hence their answer seems reasonable, I think.
I agree that the answer’s correct.
I simply think that it would be more realistic for the question to have been based on an amortizing loan; interest-only loans aren’t particularly common for mortgages.
Ironically enough this question is a variation of the CFA Curriculum question which also uses interest only. Anyway thanks all for the help.
I’m aware that the CFA Institute questions use interest only. Their authors were lazy, too.
I wrote an example question like this one for the Level II lecture notes I created for Wiley; I used an amortizing loan. Level II candidates can handle that.