Is there anything more confusing to the novice real estate investor than when your lender starts using the terms “Loan-to-Value (LTV),” “Loan-to-Cost (LTC),” and “Loan-to-After-Repair-Value (LTARV or ARV)?”
What do they mean? When are they used? Why are they used?
Although it may be tempting to write these terms off as just lending “mumbo jumbo,” keep reading, because your entire investing future may depend on them. In fact, they are the three of the most important terms to understand when applying for a real estate investment loan
Why? Because traditional, alternative, hard money, and private money lenders (for a rundown of the different types of lenders, take a look at this article) use these ratios to assess the risk associated with your loan, and if the numbers do not line up the way they want them to, they may not fund your project. If they do fund your project, they use these numbers to determine the amount of the loan they can provide.
Here is what you need to know.
IN A NUTSHELL:
LTV measures the loan amount to the VALUE of the property: LTV is the most widely used ratio in lending, often applying to all types of projects.
= LOAN AMOUNT/PROPERTY VALUE: (If the value of the property is $100,000 and the loan amount is $80,000, the Loan-to-Value ratio is 80%.)
LTC measures the loan amount to the total COST of the project: LTC applies to lending that involves construction, development, and renovation.
= LOAN AMOUNT/TOTAL COST OF PROJECT: (If the total cost of the project is $100,000 and the loan amount is $80,000, the Loan-to-Cost ratio is 80%.)
LTARV measures the loan amount to the value of the property AFTER REPAIRS: LTARV applies to lending that involves renovation.
= LOAN AMOUNT/VALUE OF PROPERTY AFTER REPAIRS: (If the value of the property after repairs is $100,000 and the loan amount is $80,000, the Loan-to-After-Repair Value ratio is 80%.)
Lenders prefer to see a lower ratio number in each category because it means that less of the property is being financed through the loan, which reduces the lender’s exposure in regard to borrower default or during market fluctuations (i.e., it’s more likely the lender can get their money back out of the property should either of these occur).
Also, when the borrower puts down a significant amount of their own funds, this gives the borrower a higher stake in the project, and motivation to complete the project as planned.
Of course, many other factors are taken into consideration for an investment loan, including the borrower’s experience, credit, income (in some cases), and project marketability.
LOAN TO VALUE (LTV): Measures the loan amount to the VALUE of the property.
Among the three terms, LTV is the most used ratio of the group and is typically the most important to your lender. This ratio represents the loan amount as a percentage of the appraised value of the property (lenders may also use the Loan-to-Purchase Price ratio based on the actual price paid for the property – see below).
A lower LTV indicates a smaller loan amount relative to the property value, which generally means lower risk to the lender.
By focusing on the LTV ratio as a risk assessment tool and leverage indicator, lenders are able to evaluate whether there is enough collateral provided by the borrower to cover a potential loss in case of default. It also helps them mitigate the risk of over-leveraging and protects their interests in case of foreclosure or a decline in property values.
LOAN TO COST (LTC): Measures the loan amount to the total COST of the project.
It represents the loan amount as a percentage of the total project cost, including land acquisition, construction expenses, and other associated costs.
By considering the loan amount relative to the project’s total cost, lenders can gauge the borrower’s financial commitment (how much are they bringing to the table), which serves one aspect of helping them assess the project’s general viability.
LOAN TO ARV: (LTARV): Measures the loan amount to the value of the property AFTER REPAIRS.
LTARV is commonly used in fix and flip or remodeling projects.
LTARV allows lenders to determine the loan amount based on the anticipated future value of the property, considering the improvements planned by the borrower, and to assess the potential profitability of a project by considering the increase in property value post-renovation.
Let’s assume we can give you a maximum leverage on a new construction loan of 85% (note: this leverage amount can change with market conditions, project details, and borrower qualifications).
This means we will lend you 85% of the base cost of your project. If you purchase a piece of land for $100K, and it’s going to cost you $300K to build, your total cost base is $400K. So, we will loan you a maximum of 85% of that, which is $340K.
We fund 100% of your construction costs, so $300K of that $340K will go towards construction in a “construction holdback.” The other $40K goes towards the purchase of the land. This means you will need $60K out of pocket for the project.
DIFFERENT LENDERS VIEW THESE RATIOS IN DIFFERENT WAYS
Different lenders may use different values when assessing Loan-to-Cost, Loan-to-Value, and Loan-to-After-Repair-Value ratios. This is because each lender has their own risk tolerance and criteria for approving loans. There are other considerations that come into play, as well, like market trends, and lender loan preferences.
The strictness of qualification criteria can depend on factors such as the lender’s risk appetite, lending policies, and the specific loan program being offered.
Traditional banks tend to have stricter qualification criteria (they want to see a lower ratio, with a higher down payment). They often adhere to conservative lending practices and require borrowers to meet specific LTV ratios. They typically assess a borrower’s creditworthiness, income stability, and other factors in addition to LTV ratios.
Alternative Lenders (like i Fund Cities) often have more flexibility in qualification criteria (they can offer a higher ratio, sometimes with less money down). They may focus on the potential profitability of the project, rather than strict LTV, LTC, or LTARV ratios. They may be willing to take on higher-risk loans and loans the bank will not. They MAY charge a slightly higher interest rate to cover that associated risk.
Hard Money Lenders also have some flexibility in their criteria and may focus more on the profitability of the project. Although they take on higher-risk loans, they typically charge much higher interest rates and fees to compensate for that risk. (If you don’t know what Hard Money is, this article: “Hard Money Lenders for Beginners,” will help!)
LENDERS USE ONE OR ALL OF THESE RATIOS, DEPENDING ON THE PROPERTY TYPE
Lenders may use one or more of these ratios to assess just one project, depending on the nature of the loan.
Fix and Flip and Renovation Loans: Lenders may use all three metrics to evaluate fix and flip or renovation project loans, where the property is already acquired or owned, and the loan is intended to cover the remodeling costs. Each ratio gives the lender a distinct perspective on the loan, and each can work together to define the final amount of the loan.
Construction and Development Loans: Lenders often use both LTV (evaluates the loan amount relative to the property’s value once construction is completed) and LTC (offers insight into the feasibility of the project based on the borrower’s contribution, and the overall project costs) for these types of loans. (Want more info on getting a New Construction Loan? We’ve got you covered here: “Tips for Obtaining a New Construction Loan.”
Rental Loans: On a standard investment property rental loan for long-term or short-term rental properties, lenders primarily use LTV (compares loan amount to current market value) and LTC (compares the loan amount to the cost of acquiring and making any improvements to make it suitable to rent) ratios to assess loan eligibility.
COMMON REAL ESTATE INDUSTRY RATIOS FOR DIFFERENT PROPERTY TYPES
The ratio thresholds for Loan-to-Cost, Loan-to-Value, and Loan-to-After-Repair Value may be different for different property types. This is because different property types also have different risks associated with them. (In a lender’s eyes, the least to most risky investment loan types are as follows: Rental, Multifamily, Fix and Flip, and New Construction.)
Here are some common maximum lending ratios in the industry for each type of loan:
LTV: 70-80% of property’s appraised value.
LTARV: (not usually assessed since there is no renovation or repair)
LTV: 70-80% of property’s appraised value.
LTC: (Borrower contributes 20-30% of purchase price as down payment.)
LTARV: (not usually assessed since there is no renovation or repair)
Fix and Flip Loan
LTV: 70-90% of property’s appraised values after repairs are completed.
LTC: 70-90% of total project cost (Borrower contributes 10-30% as equity.)
LTARV: 70-90% of property’s anticipated value after repairs.
New Construction Loan
LTV: 70 to 80% of property’s appraised value upon completion.
LTC: 70-80% of total project cost (borrower contributes 20-30% of project cost as equity.
LTARV: Typically do not use since they are building from ground up, not remodeling.
OTHER COMMON REAL ESTATE INVESTMENT LOAN METRICS
And now, for a few more metrics and acronyms … (yep – we are going there!). The following ratios are often used with other metrics to assess the risk associated with a particular loan.
Debt Service Coverage Ratio (DSCR): DSCR = Net Operating Income (NOI)/Total Debt Service
DSCR loans are commonly referred to as investment property loans or rental loans. The DSCR ratio measures the borrower’s ability to generate enough income to repay the loan.
The NOI part of the ratio looks at operating expenses including rental income, minus vacancies, and operating expenses (property management fees, maintenance costs, insurance, property taxes, etc.) minus the total amount of principal and interest payments on your loan.
The number you get shows whether the cash flow can cover the debt payments. The higher the number the better here. (DSCR = 1 means the property’s income is just enough to cover the debt. DSCR is greater than 1 means there is excess cash flow after payment of your monthly debt.)
Loan to Purchase Price Ratio (LTPP): (Loan Amount/Purchase Price) *100
This number represents the percentage of the property’s purchase price that is being financed through the loan, and the amount the borrower is borrowing. This differs from the Loan-to-Value, as properties can sometimes come in at an appraised value much higher than what the borrower paid for the property (LTV), whereas the LTPP looks at the loan in relation to the actual price paid for the property.
Loan to Gross Rent Multiplier (LGRM): Loan Amount/Gross Rental Income
LGRM is a screening tool to evaluate the income potential of the property and the loan’s relationship to that income. This metric is used more in commercial real estate rather than residential property financing.
We hope this unraveling of these three important terms has been helpful. (We know it is dry, but we have tried to make it more interesting than folding laundry, scrubbing the bathroom, or sitting in traffic!)
As lenders and experienced investors, we know how key it is to have the right information and resources to make informed decisions. That is why we are here to help you understand the terminology used when lenders assess your projects for funding, so you can make the best decisions for your investments!
Good luck and happy investing!
The i Fund Cities Team