The loan-to-value (LTV) ratio is essentially used as a measure of the risk by financial institutions and other lenders when considering a loan. Loans with higher LTV ratios are higher risk and, in most cases, result in a loan that costs more for the borrower; either by means of a higher interest rate, higher points, or both.
As the name implies, the LTV is a ratio, or percentage, of the amount of the loan compared to the value of the asset you are borrowing to purchase (or refinance, etc). The closer the amount of the loan is to the value of the property the higher the ratio will be.
The Loan-to-value formula
Calculating the loan-to-value ratio is very easy.
LTV = Loan amount / Property value
Or, the loan amount divided by the property value.
A simple example
Let's say there is a house you intend to purchase and flip that is worth $500,000. This is the value of the property in its current condition. It's important that the value is determined by an appraiser and not the amount that you feel it is worth. You are willing and able to put $80,000 down but plan to finance the balance with a loan. The loan amount would be $420,000.
LTV = $420,000 / $500,000
LTV = 0.84
LTV (expressed as a percentage): 84%
Another easy way to calculate the LTV is to subtract the percentage you are putting down on the property from 100. In this case, you are putting 16% down. If you subtract 16 from 100, you are left with 84.
How does it impact risk?
The risk that lenders take on is that the borrower may fail to make loan payments, not pay the loan off in the agreed upon time-frame and eventually have to foreclose on the property. At this point, the lender takes ownership of the property and will attempt to sell it in order to recoup the money that was lent out to purchase it. The higher the LTV, the less room there is for the lender to recoup their capital after acquiring and selling the property; thus the more risky.
Using the example from before, the loan amount was $420,000 for a property worth $500,000 (84% LTV). While at the top line, that gives the lender $80,000 worth of room, it's still a very tight for them. After you consider legal fees, commissions, holding costs, time, and fluctuations in market prices, it's likely that the lender ends up losing money after they sell the property that they had to foreclose on.
Some loans, especially hard money loans, can have an LTV of 90 to even 100%. This produces incredible risk for the lenders.
What is a good LTV?
Determining a good LTV is not easy to do. It greatly depends on a number of factors including the loan size, your credit score, your past investment experience, your relationship with the lender, the nature and timeframe of the deal, the lender's risk tolerance and many more things. The lower the LTV the lower the risk for the lender which means the greater likelihood that you will be able to secure a loan.
If you're searching for a hard money loan, we make it easy so you don't have to worry about LTV and finding a lender that's willing to lend based on it. Get started here and we will automatically connect you to lenders that fit your financing needs.