This ratio is defined as follows:
Combined Net Worth of all of the Borrowers ÷ Loan Amount
This is a ratio that is closely observed by banks but is often ignored by S&L’s and thrifts. Traditionally, this ratio had to be at least 1.0. In other words, the borrower’s net worth had to be at least as large as the loan amount requested.
During the go go days of the mid nineteen eighties, however, $600,000 net worth borrowers were regularly obtaining $2 million loans form the S&L’s. Not surprisingly, when the projects later got into trouble, these borrowers seldom had the financial wherewithal to carry the project. In other words, these borrowers didn’t own anything that they could sell off to carry the negative cash flow. As a result, the S&L’s lost billions.
After the S&L debacle, lenders began to pay more attention to this ratio. For almost a decade, 1.5 became the bank minimum. In other words, a borrower’s net worth must be at least one and a half times larger than the loan he is seeking. Commercial mortgage money is so plentiful in 2005 that banks will now even look at commercial loans where the net-worth-to-loan-size ratio is slightly less than 1.0.
Nevertheless, if you have a deal where a $400,000 borrower is trying to borrow $1 million on a leveraged real estate project, you probably would not want to bring his loan to a bank.