Debt to income ratio is one of the factors looked at by lenders when deciding whether you qualify for a business or SBA loan.
On average, lenders want to see applicants have a 40% (or less) debt to income ratio in order to qualify for an SBA loan. However, commercial lenders have more flexibility than traditional mortgage lenders and they may be able to ignore cash flowing assets when calculating debt to income ratio.
In my experience, all lenders have different specific requirements for approving loans. So, you shouldn’t ready a blog article and simply assume you won’t qualify. The best step you can take is contacting several local lenders and talking to them about their standards. You may very well find a lender willing to work with you even if you’ve been turned down several times already.
And there are so many ways to get the money you need to invest!
How To Calculate Debt To Income Ratio
Debt to income ratio is pretty easy to calculate. It’s the percentage of your income that is used to make debt payments.
Calculate monthly income
So first is to figure out your monthly recurring income. These are things like:
- Paychecks from a job
- Rent paid on rental property
- Income from investments
When I calculate my income, I have to add together the salary from my full time job, the income from our four investment properties and income from our other investments.
Let’s say you make:
- $3,400 per month from your job
- $1,600 per month from one investment property
- $1,400 per month from a second investment property
- $800 per month from an online business
Your monthly income is $7,200 ($3,400 + $1,600 + $1,400 + $800).
Calculate monthly debt burden
Next you need to add up your monthly debt payments. These can be things like:
- Mortgage payments (including payments for taxes and insurance)
- Car payments
- Student loan payments
- Monthly credit card payments
- Time share payments
- Personal loan payments
- Child support
- Alimony payments
- Co-signed loan payments
You do NOT need to include:
- Utility payments
- Car insurance
- Health insurance
- Cell phone bill
- Internet bill
- Cable bill
- Groceries or other living expenses
So your monthly expenses might look something like this:
- $800 per month mortgage on primary residence (includes insurance and taxes)
- $600 per month for mortgage on investment property (includes insurance and taxes)
- $500 per month for mortgage on second investment property (includes insurance and taxes)
- $400 per month for student loan
Your total monthly debt burden would be $2,300 ($800 + $600 + $500 + $400).
Divide monthly income by monthly debt
Our monthly income was $7,200 and our monthly debt was $2,300.
So our debt to income ratio is 32% ($2,300 ÷ $7,200).
How DTI Is Used By Lenders
Now we’ve got a Debt to Income ratio (DTI), but what does it mean? Well, lenders use this ratio to determine how much is safe to lend to a particular person.
They have standards in place for what constitutes an acceptable debt to income ratio.
Let’s say the standard was that they could give out loans up to a 50% debt to income ratio.
In our previous example, we had a monthly income of $7,200. A 50% DTI with that income would be $3,600 ($7,200 x 0.5).
Since we already have $2,300 in monthly payments, that would allow the lender to give us a loan that had up to a $1,300 monthly payment ($3,600 – $2,300).
Different lenders will have different numbers of acceptable debt to income ratio for their lending. And those numbers can change based on certain characteristics of the individual requesting a loan. For example if our credit score is 800, we might be able to get a debt to income ratio of 50%, but if our credit score is 650, then we might only be able to get a debt to income ratio of 40%.
Debt To Income Ratio For SBA Loans
Now let’s talk about what kind of debt to income ratio is allowed for SBA loans. Since SBA loans are actually just regular business loans that are partially guaranteed by the Small Business Administration, there isn’t only one single answer.
The Debt to Income ratio allowed will depend on the actual lender giving you the loan. Usually, a Debt to Income ratio of 40% is the maximum allowed on a business or SBA loan.
But commercial or business lenders are much more flexible than traditional mortgage lenders. Lenders can do things to change your debt to income ratio for commercial loans.
All the investment property Kate and I own are in our own names. That means the property isn’t owned by a business, it’s owned by us. So it counts towards our DTI ratio when we try to qualify for a traditional home loan.
One of our investment properties has positive cash flow, but it has a debt to income ratio of about 55%. Even though that property makes me richer and puts money in my pocket every month, owning it makes it harder for me to get a loan!
This is where the flexibility of business lenders can help. They can treat that property as an isolated self sustaining business and not count it towards your debt to income ratio on your SBA loan.
You should always get in touch with a local commercial lender and get information from them before you assume you can’t get a loan.
Your loan officer WANTS to lend you the money. They are often limited by the rules their bank puts in place. A good loan officer will walk you through the process and do their best to help you qualify for a loan. And if you don’t qualify, they can help you figure out what steps you need to take to get qualified.
Other Considerations For SBA Loans
Even though debt to income ratio is an important metric for getting an SBA loan, it’s not the only one.
Debt service coverage ratio
Often, your lender can consider the cash flow of your business (or the business you’re going to purchase) in the consideration for debt qualification.
Debt service coverage ratio is a separate way the lender can think about your ability to make monthly payments on a loan.
Instead of looking at the individual and his or her ability to pay the loan, debt service coverage ratio looks at the business itself and analyzes that business’ ability to pay the loan. This can also help individuals who have less than ideal debt to income ratios qualify for an SBA loan.
Another thing business lenders will look at is collateral. If there is a failure to make payments towards the loan, the bank wants to take ownership of something they can sell to cover the debt owed.
A super common type of collateral is real estate. If your business, or the business you’re purchasing, owns some real estate, that can be used as collateral to secure the SBA loan.
For someone like me, who is looking to buy an online business with no real assets, satisfying the collateral requirements of a lender will have to come from my personal assets. At least, the lenders I’ve talked to won’t allow an online business to act as collateral for a business or SBA loan.
Remember, debt to income ratio is only one of the metrics used by lenders to determine your loan eligibility. Don’t assume that you can’t get an SBA loan just because you have a DTI ratio at or above 40%.
I’ve spoken to at least 10 different lenders in my area, and some of them have shut me down almost immediately. But different lenders prioritize different things. And some lenders will treat your cash flowing investments as self sustaining entities that don’t count towards debt to income ratio.
Never assume you won’t qualify. Just get in touch with several local lenders and start working with them to see how you can qualify. You’ll almost certainly find some who want to help you.