LTV, DSCR and Debt Yield: The Three Constraints That Size a Loan
A commercial mortgage is sized by whichever of three tests binds first. Knowing which one binds tells you what to fix.
Finance · 613 words · updated 2026-08-26
Lenders do not size a loan on one ratio. They calculate a proceeds figure under each of three tests and lend the lowest. Working out which constraint binds is the difference between negotiating usefully and negotiating in the dark.
Loan to value
LTV = Loan amount ÷ Appraised value
The value-based limit. It is the weakest of the three tests because it inherits every assumption in the appraisal — including the cap rate, which moves with the same interest rates that move the loan. When cap rates rise, LTV-constrained proceeds fall twice over.
Debt service coverage ratio
DSCR = Net operating income ÷ Annual debt service
The cash-flow test. A 1.25× requirement means NOI must exceed debt service by 25%. Proceeds implied by DSCR depend on the interest rate and the amortisation schedule, because debt service includes principal. Working backwards: maximum annual debt service = NOI ÷ required DSCR, then convert that payment to a principal balance at the quoted rate and amortisation.
Two details matter. First, lenders usually size on their own underwritten NOI — with market vacancy, a management fee and reserves — not the borrower's. Second, many size on a stressed rate or a floor rate above the actual coupon, which cuts proceeds regardless of what the borrower is paying today.
Debt yield
Debt yield = Net operating income ÷ Loan amount
The lender's unlevered return if it took the keys tomorrow. It contains no interest rate and no amortisation assumption, which is exactly why it became the dominant CMBS test after 2008: it cannot be gamed by interest-only periods or long amortisation, and it does not depend on an appraiser's cap rate. A 10% debt yield requirement caps the loan at ten times NOI, full stop.
Which one binds
Take a property with $1,000,000 of underwritten NOI, a $14,000,000 appraised value, and a lender quoting 65% LTV, 1.25× DSCR and a 9.5% minimum debt yield at 6.25% interest on a 30-year amortisation:
- LTV test: 65% × $14,000,000 = $9,100,000
- DSCR test: maximum debt service = $1,000,000 ÷ 1.25 = $800,000 per year; at 6.25% on 30-year amortisation that supports roughly $10,830,000
- Debt yield test: $1,000,000 ÷ 9.5% = $10,526,000
LTV binds, at $9.1 million. The useful conclusion is not "we got 65%" — it is that arguing about DSCR or amortisation will not move proceeds, and challenging the valuation, or bringing more equity, is the only lever.
Change the facts — a low-cap-rate market where value is high relative to income — and debt yield binds instead. Then a better appraisal is worthless and only more NOI helps.
Interest-only and the refinancing cliff
An interest-only period raises DSCR mechanically because debt service excludes principal. It does not change debt yield. A loan sized on DSCR during an IO period can fail its own coverage test the moment amortisation begins — which is why lenders often test coverage on a fully amortising basis even when quoting IO.
The same arithmetic drives maturity risk. A loan originated at a 4% coupon and a 9% debt yield refinances comfortably at 4%; at 7% it may not refinance at all without an equity paydown, because the constraint that binds at maturity is not the one that bound at origination.
Other terms that move real cost
- Recourse — full, partial, or non-recourse with standard carve-outs ("bad boy" guaranties).
- Prepayment — open, step-down, yield maintenance, or defeasance. Defeasance in a falling-rate environment can cost more than the remaining interest.
- Reserves — TI/LC, replacement, tax and insurance escrows, and cash-management triggers tied to a DSCR or debt-yield covenant test.
- Covenants — ongoing DSCR and debt-yield tests that can sweep cash flow long before an actual default.