Loan-To-Value Ratio Guide
You might see the term LTV Ratio when making a commercial real estate purchase. Find out how it can affect buying decisions.
When applying for a small business loan, upgrading real estate, or collaborating with a lender in one way or another, you’ve probably come across an unfamiliar term: LTV ratio.
LTV stands for Loan-To-Value ratio, and it plays a big role in the world of lending. Keep on reading to find out more.
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What Is A Loan-To-Value Ratio?
You’ll most commonly see an LTV ratio used in hard money loans, but banks also factor this ratio when calculating mortgages.
An LTV ratio is a number that represents the potential risk of a loan to the lender. This ratio is a percentage, and the higher the number, the greater the perceived risk to the lender. When referencing a mortgage, it calculates the amount of debt versus the value of the property being mortgaged and assesses risk based on that number.
How Is The LTV Ratio Calculated?
The LTV ratio is one of the simplest financial calculations.
The formula is: Amount borrowed / Value of the property = Decimal to convert to percentage
As the percentage increases, the lender takes on more risk.
If a lender finances 100% of the property value, they are providing full financing. High LTV ratio loans are typically only offered to borrowers with excellent credit.
Ex: You take out a $100,000 loan on a piece of property estimated to be worth $140,000, so $100,000 / $140,000 = 0.7142. Your LTV ratio would be 71%.
Why Are Loan-To-Value Ratios Important To Lenders?
Hard money lenders use LTV ratios to assess risk just like more traditional lending institutions. There are some small differences in how they use it, however. Because of the higher risk involved with hard money lending, the lenders have to consider the strong possibility that the borrower will default.
Whereas banks might heavily factor credit into their calculations along with LTV, hard money lenders value LTV substantially more than credit. Some lenders may not care about credit at all. As a counterbalance, they use the equity the borrower puts into the property as a security. Effectively, this means hard money lenders will, in most cases, look for a lower LTV than a bank would.
What Is A Good Loan-To-Value Ratio?
This question can be broken down into simpler terms: how much are lenders willing to cover?
In addition to any background checks the hard money lender may decide to factor in, the property’s qualities will be considered. Properties in booming real estate markets and “up-and-coming” neighborhoods may push the lender’s LTV tolerance close to 75%, often considered the upper limit for hard money. In contrast, a property in a poor market or a remote one will push the maximum LTV closer to zero.
Similarly, the state of the property will play a large role in how much risk the hard money lender is willing to take on. The better the state of the property, the higher the LTV can go.
Where Can I Get The Best Real Estate Loan?
While the best commercial real estate loans will allow you to borrow larger amounts, have low-interest rates, and have long repayment terms, we will always recommend looking into SBA lenders before considering other options.
There are different kinds of SBA real estate loans for small business owners to choose from.
The best options are 7(a) loans (check out our guide) and 504 loans (read our guide). There are different pros and cons to each, so do your research before deciding which to apply for.
Final Thoughts On LTV Ratios
It’s always a good idea to try and understand how your lender is making their underwriting decisions so you know you’re getting a good deal.
Fortunately, you will eventually see your LTV ratio in the form of the amount of money they offer you in the end, so it isn’t worth stressing too much over.
The most important thing to remember is that the more the lender is willing to cover, the higher they’ve assessed the value of the property.
Hopefully, this overview has given you a basic understanding of what LTV is and how it’s used in real estate transactions. Next, we recommend checking out our article on commercial real estate loans to learn more about the different types, rates, and requirements you may encounter when purchasing property for your business.