LTV or ‘Loan to Value’ is another key metric used by hard money and traditional lenders to assess the risk of a loan.
The higher the LTV ratio, the higher the risk level.
That means a greater chance of the borrower defaulting on the loan and a greater likelihood the loan application will be rejected.
Lenders use the LTV in conjunction with the LTC (loan to cost) ratio and ARV (after repair value) to assess the risk of a loan.
Typically, if a loan application with a high LTV ratio is approved, it will attract a higher interest rate to offset that risk.
There may also be a requirement for the borrower to buy mortgage insurance in the event they default on the loan.
Here’s how to calculate the LTV, how to use it and why it is so important.
Calculating the LTV (Loan to Value)
The formula for calculating the LTV of a property is basic division.
LTV = Loan amount / Value of property
That number is then multiplied by 100 and expressed as a percentage.
The loan amount is the total amount of money provided by the lender.
Here are a couple of examples.
Example A
Joe is an aspiring flipper in California and identifies a house perfect for renovation valued at $1,000,000.
He has a downpayment of $350,000 and hence needs to borrow $650,000 to buy the property.
His LTV is $650,000 / $1,000,000 or 65%.
Joe’s significant downpayment has kept his LTV ratio to an acceptable level which will likely see his loan approved.
Example B
Tess is an experienced property developer and has a long relationship with her hard money lender.
She wants to redevelop a group of apartments valued at $3,000,000 but only has a downpayment of $500,000.
Tess needs to borrow $2,500,000 to begin the project.
Her LTV is $2,500,000 / $3,000,000 or 83.33%.
It is in the upper limits of what most hard money lenders would consider approving.
But Tess’ experience and relationship with her hard money lender work in her favour.
The loan is approved but under strict conditions and with a higher interest rate.
What is a good LTV ratio?
LTV ratios are a key component lenders use when deciding not just whether to approve a loan but what interest rates and conditions to impose on it.
Traditional lenders consider LTV ratios between 60-70% as being of lower risk.
These loans are likely to be approved with lower interest rates and fewer fees.
LTV ratios between 80-90% are considered at the top end in terms of risk.
They are more likely to be rejected or if approved, attract much higher interest rates, fees and stricter terms.
Hard money lenders usually more flexible than traditional lenders.
They generally approve loans with LTV ratios as high as 75%.
Some may even underwrite projects with LTV ratios significantly higher.
How LTV ratios relate to flippers and developers in California
Understanding the LTV ratio is critical for flippers and property developers in California.
That’s because it allows them to better assess the type of properties they can afford to flip.
The high price of California real estate means that a small percentage difference in LTV may reflect a significant amount of money.
A 5% shift on a $2,000,000 property represents $100,000.
The LTV ratio is intrinsically tied to the following:
Loan amount
If a flipper wants to buy a property valued at $1,000,000 and a lender sets the LTV ratio at 70%, they are effectively limiting the loan amount to $700,000.
This means the flipper needs to find a downpayment of $300,000.
Downpayment
If your LTV ratio is too high and a lender won’t approve the loan, you need to reduce it.
This can be done searching for a cheaper property to redevelop.
Or, you could increase your downpayment which will reduce the amount of money you need to borrow.
This may require the liquidation of other assets to achieve.
Terms and conditions
A lower LTV reduces the lender’s risk and gives the borrower better terms and conditions.
That generally means a lower interest rate.
A lower LTV also means less leverage which can protect the borrower if market conditions shift or the project runs into delays.
Project feasibility
LTV is often closely tied to the ARV (After Repair Value) for fix and flip projects.
Lenders generally offer between 65-75% of the ARV so you’ll need to ensure your renovation budget and purchase price align with that.
For example, if the ARV of a fix-and-flip project is $1,200,000 and the lender is offering 70% of the LTV, you can borrow up to $840,000.
If the purchase price is $800,000 and renovations cost $100,000, you’ll need $60,000 cash to cover the shortfall.
Refinancing opportunities
Refinancing to a more sustainable traditional loan is a sensible exit strategy for many flippers and developers upon completion of their project.
A lower LTV ratio makes that process much easier and affordable.
If a property’s value increases significantly after renovations, the LTV on a refinanced loan will be much lower, almost certainly qualifying the lender for better terms and conditions.
LTV vs LTC vs ARV
It is important for flippers and developers to understand all three metrics.
It allows them to make smart decisions about the properties they can afford to redevelop.
In a nutshell:
LTV – Loan to Value determines how much money you can borrow, along with the terms and conditions
LTC – Loan to Cost takes into account the total cost of the project including the purchase price, renovations, permits and fees
ARV – After Repair Value is the property’s potential resale value, allowing you to build a profit margin into your project
Get advice today
The LTV or Loan to Value is a basic calculation lenders use to determine the risk they are prepared to accept for a project.
That level of risk and in turn the amount loaned may vary depending on the credibility of the borrower and the relationship they have with the lender.
That’s why establishing a relationship with an experienced and respected hard money lender is so valuable for flippers.
In California, you need look no further than Equidy.
Equidy is a hard money lender with one of the most trusted, esteemed and enviable reputations on the west coast.
They lend hard money to their valued clients for projects with high LTC and LTV ratios when traditional lenders refuse.
They never waver from their core belief that anything is possible.
And Equidy is determined to prove it each and every day.
Even in challenging economic times, they strive to reward entrepreneurship and always help their clients turn their wealth creation dreams into reality.
But Equidy is much more than just a hard money lender.
Equidy has an intimate and personal history with property, and has immersed itself in all aspects of real estate and property development in California for more than 40 years.
They have a deep-seated knowledge of the industry, working closely and creatively with their clients, providing their wealth of knowledge and support network as their projects take shape.
And they enjoy long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimise the risk to all parties.
Make no mistake, no-one knows more about property development in the golden state than Equidy.
Contact Equidy today to book your free strategy call.
