What are the Guidelines for Church Underwriting?
When deciding whether or not to give a church a loan, there are several things that a lender will look at as they make their decision, whether for a new loan or refinancing. It can be frustrating when you’re trying to run a church and do good work for your community, but financial problems are constantly nagging you. It would be nice if we lived in a paradisiacal world where money wasn’t needed, where we had the funds we needed to do all the great things we want to: to feed the hungry and clothe the naked. But for now we have to look forward to that as a righteous desire that will be fulfilled in the future–and we have to keep financial records and do our bookkeeping.
So when we need money for something at our church–a construction project, an expansion, a refinancing–we need to gather all our records together and talk to a lender. But what will they need? What are the guidelines for church underwriting?
What are Church Underwriting Ratios?
There are usually three ratios that lenders look at when they make an underwriting decision for a church. These are the debt to coverage ratio (DCR), loan to value ratio (LTV), and debt to income ratio (debt: income).
Generally speaking, the guidelines for these ratios are:
DCR: between 1.0 and 1.25
Debt to Coverage Ratio
This is a ratio that examines whether the church has income available to make the payments on the debt. The lender wants to be sure that the church can pay back the money that is owed, and this is determined by the DCR.
This is a little bit of a complex ratio to calculate. It looks at how much income the church had in the previous year that it could send to debt payments. To figure this out, you take change in net assets and add back in interest and depreciation. This number represents the amount you would have after you’ve paid all your other expenses. You then divide this by the P&I payments (principal and interest).
So, this gives lenders a good idea of whether the church has a history of income that would cover the loan payments.
If your loan is going to have annual payments of $100,000, but your money available to pay debt is $90,000, then that gives you a DCR of 0.9. As the guideline is between 1.0 and 1.25, you’d want your money available to be between $100,000 and $125,000.
Now, these are just guidelines that various lenders follow and are not to be taken as gospel. Some lenders may require a 1.3 minimum and some may say 0.95 is okay, but those would be outliers. And anything below a 1.0 is very rare and would need extraordinary circumstances to justify it as it essentially shows that there is not enough money available to pay the debt. There would have to have been a major, demonstrable change in the current year’s finances and outlook to justify a low DCR.
If you have a poor DCR, the best way to fix it is to increase your income without increasing expenses, which is a tall order.
Loan to Value
The next ratio that a lender will always look at when calculating whether or not to lend money to a church is the loan to value (LTV). Simply put, the LTV is the ratio of the balance of the loan as opposed to the appraised real estate that is securing the loan. The obvious purpose of this ratio is to determine whether the loan could be paid if the real estate was foreclosed on. This may seem grim to think about, but it’s something that the underwriter is going to want to know before they lay out any money.
The typical required ratio is 70%, meaning that the loan shouldn’t be more than 70% of the real estate value.
The hard thing is that some lenders rely on their own appraisers and ask for very conservative appraisals. This is, again, an obvious move on the lenders’ part because it’s asking them to make their decision based on the worst conditions: that the church has to foreclose and that the real estate market isn’t good. (This is reasonable because it would very possibly be a bad economy that caused the church to close, so the foreclosed property wouldn’t get top dollar.)
So if your loan is for $3 million and your church is appraised at $4 million, then the LTV would be 75%, which would likely be denied by the lender as it’s above the 70% cutoff.
One thing to remember is that you’re calculating the LTV off the appraised value, not the net book value on the financial statements.
Debt to Income
The third ratio that a lender will look at when deciding whether to underwrite a loan is the debt to income ratio or debt:income. This ratio is designed to examine the long-term debt and compare it to the total revenue. This would include all forms of revenue for the church, including not just contributions and giving but also school tuitions if that applies.
The guideline for debt:income is 3x, meaning that the debt can be 3 times the total revenue.
So if the loan was $3 million and the total revenue was $1 million, that would give a debt:income of 3, so perfect. But if the loan was for any higher, or the revenue any lower, then the debt:income would dip below 3x.
Audited or Reviewed Financial Statements
Another thing you’re going to need to know is the guidelines for the financial statements. This may seem odd, because aren’t all financial statements made the same? You’d be surprised.
The rule of thumb here is that the more money you’re applying for in your loan, the higher scrutiny your financial statements are going to be under. Your CPA is going to be involved in this discussion.
There is a difference between an audited financial statement, a reviewed financial statement, an a compiled financial statement. Typically, for a loan of more than $5 million, you’ll need audited financial statements. For under $5 million, you’ll need reviewed financial statements. And for under $1 million you can (sometimes) get away with a compiled financial statement. For definitions of what audited, reviewed, and compiled mean, talk to your CPA, but just know that they’re referring to how strictly examined the financial statements are going to be.
Another measuring stick that some lenders use is something called a “stress test”. This looks at whether churches would be able to survive an interest rate increase in the future. In this case, the stress test changes the interest rate to 7.5% and recalculates the DCR. With the higher interest rate, it would raise the monthly payments and annual payment, which would mean that a loan that would have been covered in that 1.0 to 1.25 range before could now be in danger. This is especially reviewed if the DCR is close to the 1.0 mark, or even below it. A DCR of 1.0 could drop to 0.8 or 0.7 if the interest rate jumped to 7.5%.
Cash on Hand
A final consideration that a lender might make is the amount of cash on hand. Though this number can change for each lender, one guideline is to have enough cash on hand for three months salary plus debt payments.