LOGIN Real Estate Financing Explained: LTC vs LTV
When applying for a commercial loan, hard money lenders may use the loan-to-cost ratio or the loan-to-value ratio during the underwriting process to determine the risk associated with the loan. When applying for a loan, it is crucial to understand these ratios and how they affect your chances of securing a loan.
We’ll look at the loan-to-cost and loan-to-value ratios, how they are calculated, and how lenders use them during the loan approval process.
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What Is the Loan-to-Cost Ratio?
The loan-to-cost (LTC) ratio compares a project’s financing amount to the project’s total cost. The LTC ratio provides the percentage of the project cost covered by the funding.
Calculating the Loan-to-Cost Ratio
Lenders calculate the loan-to-cost ratio by dividing the amount of the loan by the total cost of the project:
Loan-to-Cost = Amount of Loan / Total Project Cost
The total project cost includes all the hard construction costs to develop the project. The construction costs include materials, labor, professional services (such as architects), permits, and other fees.
Let’s look at an example.
A project’s projected cost is $500,000, and the developer is seeking a loan of $350,000.
The loan-to-cost ratio for this project is $350,000 / $500,000, or 70%.
When Is Loan-to-Cost Typically Used?
Lenders typically use the loan-to-cost ratio when underwriting construction projects. Hard money lenders calculate this ratio to determine the risk associated with financing a project. A higher loan-to-cost ratio indicates a higher risk for the lender.
If the loan-to-cost ratio is too high, the borrower may need to reduce the loan amount or decrease the project costs to qualify for the loan.
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What Is the Loan-to-Value Ratio?
While the loan-to-cost ratio compares the amount of financing to the project cost, the loan-to-value (LTV) ratio compares the amount of financing to the property’s future value after project completion.
Calculating the Loan-to-Value Ratio
Lenders calculate the loan-to-value ratio by dividing the amount of financing for a project by the expected value of the property once completed:
Loan-to-Value = Amount of Loan / Projected Value
Let’s consider another example.
A developer is looking for a $100,000 loan, and the property’s expected value post-completion is $300,000. In this case, the loan-to-value ratio is $100,000 / $250,000, or 40%.
When Is Loan-to-Value Typically Used?
Lenders use the loan-to-value ratio when underwriting renovations and flips of an existing property. If a borrower seeks a loan to renovate an investment property for a quick sale, the lender will look at the loan-to-value ratio.
The LTV ratio indicates the risk associated with a loan for a flip because it compares the loan amount to the property’s future value.
Work with a Trusted Partner
While understanding the LTC and LTV ratios will give you a leg up when seeking a loan, you also need to work with a lender experienced in supporting clients through the lending process.
REID Lending Partners is one of the Mid-Atlantic’s premier commercial private lenders. They offer quick approvals, no minimum credit score, and up to 75% loan-to-value. Reach out to REID Lending Partners to discuss your project today!