How do lenders determine the maximum loan amount?

They calculate the maximum loan permitted by each underwriting constraint (debt service coverage, loan-to-value and debt yield, plus loan-to-cost in construction lending) and offer the smallest of those amounts.

Which constraint usually limits a commercial loan?

It varies with the rate environment. When rates are low relative to cap rates, loan-to-value typically binds. When rates rise, debt service coverage tightens and usually becomes the governing limit.

What is an equity gap?

The difference between the total capital a transaction requires and the loan the property actually supports. It must be funded with additional equity, subordinate debt such as mezzanine or preferred equity, or by renegotiating the purchase price.

Loan Sizing: definition and worked example

Globalbiz CRE Academy defines Loan Sizing as follows: Loan sizing is the process of determining the maximum loan a property supports by testing it against every applicable underwriting constraint (debt service coverage, loan-to-value, debt yield and, in construction, loan-to-cost) and lending the smallest result.

How it works

The central discipline of loan sizing is that the constraints are not averaged, weighted or negotiated against each other. Each one produces a maximum loan amount, and the lender offers the lowest of them. A borrower who satisfies three tests and fails the fourth is sized by the fourth. This is why asking "what LTV will you do?" is usually the wrong question: the answer may be 70%, while the deal sizes at 61% because DSCR binds first.

Which constraint binds moves with the interest rate environment, and predictably. When rates are low, debt service is cheap, so the coverage test is easy to satisfy and LTV usually governs. When rates rise, debt service rises with them, DSCR tightens, and coverage becomes the binding constraint, while the property's value and income may not have changed at all. This single mechanism explains most of the reduction in available leverage during a tightening cycle.

Solving each constraint is straightforward arithmetic run backwards. The DSCR limit is the loan whose annual debt service equals NOI divided by the minimum ratio. The debt yield limit is NOI divided by the minimum yield. The LTV limit is value times the maximum percentage. The lowest of these is the offer, and the difference between it and the borrower's request is the equity gap that must be filled from somewhere.

Good practice is to size the deal before spending money on it. Third-party reports, legal fees and deposit risk all come before the loan is final, and a borrower who has computed the binding constraint at intake knows the realistic proceeds before committing. The most common failure in origination is discovering the binding constraint after the appraisal arrives.

Worked example

A property with $600,000 of NOI and a $9,000,000 appraised value. The lender's terms: 1.25x minimum DSCR, 9.0% minimum debt yield, 70% maximum LTV, priced at 6.5% on a 30-year amortization. The borrower has requested $6,500,000.

Step	Calculation	Result
DSCR limit: maximum annual debt service	$600,000 ÷ 1.25	$480,000
DSCR limit: loan supported by that payment	$40,000 per month at 6.5% over 360 months	$6,328,000
Debt yield limit	$600,000 ÷ 0.09	$6,666,667
LTV limit	$9,000,000 × 0.70	$6,300,000
Binding constraint: the smallest	min($6,328,000, $6,666,667, $6,300,000)	$6,300,000 (LTV)

LTV binds, at $6,300,000, and the borrower's $6,500,000 request falls $200,000 short. Note how narrow the margin is: DSCR would have bound at $6,328,000, only $28,000 higher. Raise the interest rate to 7.25% and the DSCR limit drops to roughly $5,862,000, making coverage the binding constraint and cutting proceeds by $436,000, from a rate change alone, with the property untouched.

How it compares

The four sizing constraints and when each tends to bind
Constraint	Formula for maximum loan	Typically binds when
DSCR	Loan supported by NOI ÷ minimum DSCR	Interest rates are high relative to cap rates
Debt Yield	NOI ÷ minimum debt yield	Cap rates are low and values look rich
LTV	Value × maximum LTV	Interest rates are low and coverage is comfortable
LTC	Total project cost × maximum LTC	Construction and development lending

Common mistakes

Sizing on the headline LTV alone: LTV is the most quoted constraint and frequently not the binding one.
Using the borrower's NOI rather than the underwritten figure: Every constraint except LTV has NOI in the numerator. A 9% overstatement of NOI overstates supportable proceeds by roughly 9%.
Forgetting that proceeds fall when rates rise, even if the property is unchanged: Debt service is in the DSCR denominator. The property did not get worse; the debt got more expensive.

Frequently asked questions

How do lenders determine the maximum loan amount?: They calculate the maximum loan permitted by each underwriting constraint (debt service coverage, loan-to-value and debt yield, plus loan-to-cost in construction lending) and offer the smallest of those amounts.
Which constraint usually limits a commercial loan?: It varies with the rate environment. When rates are low relative to cap rates, loan-to-value typically binds. When rates rise, debt service coverage tightens and usually becomes the governing limit.
What is an equity gap?: The difference between the total capital a transaction requires and the loan the property actually supports. It must be funded with additional equity, subordinate debt such as mezzanine or preferred equity, or by renegotiating the purchase price.