Loan to Value
An LTV represents the amount of debt in relation to the value of the collateral tied to a deal.
What Is Loan to Value?
As a key factor that lenders look at when determining the risk of loaning money in a commercial mortgage transaction, the loan-to-value ratio — most commonly referred to as LTV — represents the amount of debt related to the value of a property. The loan-to-value ratio is a critical component of mortgage underwriting, as it can immediately reveal to lenders the amount of equity a borrower will have in the asset and their leverage in the deal.
When looking at LTV, the rule of thumb is that the lower the LTV, the lower the lender’s risk. In fact, many loan programs have LTV maximums in place as a standard risk mitigation measure. LTV is often scrutinized along with similar risk mitigation metrics such as debt service coverage ratio, debt yield, and loan to cost. While the loan-to-value ratio plays an important role in most commercial mortgage finance and refinance transactions, lenders tend to pay closer attention to the LTC for new construction and rehabilitation financing.
Calculating Loan-to-Value Ratio
The loan-to-value ratio may be an important metric for underwriters, but it can be quite helpful for investors to be able to determine the LTV of a transaction. This can help them understand what financing may be available to them given their current capital. Conversely, understanding the LTV requirement of a loan product helps investors determine the amount necessary to make a down payment towards the financing. In order to find the LTV of a transaction there a couple of statistics an investor must know:
The appraised value (or sale price) of the collateral asset
The amount that will be financed (after subtracting any down payment amount when applicable)
With those figures handy, the LTV can be determined using a simple formula.
LTV Formula
LTV = Loan Amount ÷ Total Value
As an example, if a borrower seeks to finance the purchase of a property that is appraised at a value of $200,000 and is willing to make a down payment of $50,000, the borrower would need $150,000 of financing. The loan-to-value ratio would be 75% ($150,000 ÷ $200,000).
Loan to Value Calculator
Related Questions
What is the definition of loan to value?
Loan-to-value ratio (LTV) is a metric that compares the size of loan to the value of an asset. It is expressed as a percentage and is used to determine the ratio of a particular debt (like a first mortgage) relative to the value of the collateral (such as a multifamily or other commercial property). For example, if a borrower owns a property worth $10 million and is looking to refinance the first mortgage for $8 million, the LTV is 80%.
Lenders utilize this figure to determine their level of risk as well as the borrower leverage in a transaction. The rule is the lower the LTV, the lower the risk. This formula is used primarily in the case of standard acquisitions and refinances. In the cases of multifamily property rehabilitation or ground-up construction, other factors like LTC (loan-to-cost) become more important factors.
For more information, please see Loan-to-Value Ratio (LTV) Definition and Understanding Loan-To-Value (LTV).
What is the maximum loan to value ratio for commercial real estate?
The maximum loan to value ratio for commercial real estate depends on the property type, tenancy, underwriting factors, loan terms, market, sponsorship, and recourse. Generally, a lower loan to value ratio results in more competitive commercial loan terms and rates, whereas a high loan to value ratio results in higher risk and less advantageous loan terms for the borrower. For example, if a property is valued at $1 million and a lender restricts its offer to a 70% LTV, you will be unable to get a loan larger than $700,000. You can use this loan to value ratio calculator to easily calculate the loan to value ratio.
What are the benefits of a low loan to value ratio?
The benefits of a low loan to value ratio (LTV) are that lenders will assess the loan as lower risk and may result in a lower interest rate or a larger loan amount. A lower LTV ratio also means that the borrower will have to put less money down and can therefore use their capital for other investments.
For more information, please see the following sources:
What are the risks associated with a high loan to value ratio?
High LTV loans are considered riskier for lenders because there is less equity in the property that can be recovered if the borrower defaults. This means that lenders may charge higher interest rates for high LTV loans, as they are taking on more risk. Additionally, lenders may require additional security or collateral to secure the loan.
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How does loan to value affect the interest rate of a loan?
The higher the loan to value (LTV) ratio, the riskier the loan is for the lender. As a result, higher LTV loans may result in higher interest rates. For HUD 223(f) loans, HUD permits up to 85% LTV for market rate properties, up to 87% LTV for affordable properties, and up to 90% LTV for properties using rental assistance.
What are the most common loan to value ratios for commercial real estate financing?
The most common loan to value ratios for commercial real estate financing are typically 70% or 75%. This means that the loan amount is limited to 70-75% of the property's value. For example, if a property is valued at $1 million, the loan amount would be limited to $700,000 - $750,000.
This information was sourced from Understanding Loan Ratios in Multifamily and Commercial Real Estate and How to Get a Commercial Real Estate Loan.