Why do banks scrutinize Cash Out in a Sources & Uses?

Banks will act differently based on where they are putting loan proceeds. If some goes into your pocket, it changes their thinking. Here's why.

Tim Milazzo
Share this:

✔️LTV below maximum

✔️DSCR above minimum

✔️Healthy Debt Yield

✔️No defaults or bankruptcies

❌Loan denied due to cash out

How frustrating! You bought a property at a great price, fixed it up, and upped the cash flow. But now your bank won’t approve your loan because you’re trying to take cash out. What gives?

I’m going to explain, but first let me say this. The cash-out refinance is a completely valid strategy in commercial real estate investing. Your loan request may be perfectly reasonable, whatever a bank says. Your loan officer might even agree.

But there’s a process to making credit decisions at a regulated financial institutions that can’t be circumvented. This post is going to apply to banks and credit unions.

Cash in

When determining an acceptable uses of funds on a commercial mortgage loan, a regulated lender needs to be able to trace the cash that has gone in to a property, along with the source of funds. In the simplest acquisition deals, the sources of funds are simply the principal owner’s cash, plus a loan funding, on the day of acquisition. In that case, you simply look at all the money the buyer is supplying (or has supplied) in that transaction.

Capital expenditures into the property count too. If you renovate, add amenities, purchase supplies or pay contractors to fix or upgrade aspects of the structure, that’s also cash into the property.

Cash out

Once you determine the amount of cash invested into the property, you can calculate a true “cash out” number for a refinance. If you bought a property at $1 Million, put an additional $250,000 in via capital expenditures, and then refinance with a loan size of $1,500,000, you would call that final $250,000 going back into the borrower’s pocket “cash out”. Reimbursing the borrower for the $250,000 they spent in capital expenditures would not be considered cash out.

In this scenario, the borrower would no longer have “skin in the game”. The cash that they put in to the property is exceeded by the cash they have taken out. This can be a problem with certain lenders.

The Thoughts

A couple of reasons why an underwriter may be unsettled by a large amount of cash out:

  1. If the borrower has “nothing to lose”, they may not focus on mitigating financial risk on the property as well.
  2. The more cash that goes out into the borrower’s pocket, particularly in high leverage situations, the less is going into the property to boost NOI, and DSCR is lowered as well due to the higher loan amount.
  3. The lender can no longer track the use of their loan proceeds. It could be going to any number of things, from supporting the borrower’s lifestyle to funding a business venture that the lender wouldn’t want to be associated with.

The Process

There are no blanket, federal rules of the use of cash when refinancing commercial properties. Rules about cash out proceeds are particular to each lender as determined by internal credit policy. Banks and credit unions above a certain size do have rules about the cash reserves they need to keep on hand for any loans deemed “high volatility”, like construction or value-add loans without a healthy in-place DSCR. But typically the people at a bank or credit union that sign off on a loan will be the members of the credit committee. Their policies and decisions are developed by an executive with the title of Chief Credit Officer or something similar. They’ll have their view of what uses of cash are acceptable to the bank.

The Result

If your ideal financing scenario includes a lot of cash out, finding the right lender that can underwrite it into the loan is key. Credit policies vary widely with regard to this issue, so finding a lender that is reasonable will lead to the best result if you need to take cash out. It’s your property — you deserve to find the right capital partner that aligns with your goals.

StackSource is a tech-enabled commercial real estate loan platform. We connect investors who are developing or acquiring commercial properties with financing options like banks, insurance companies, and debt funds through a transparent online process. We’re taking the best of commercial mortgage brokerage and updating it for the 21st century. Learn more at StackSource.com.