LTV vs. LTC: What to Know for Your Investment Property
When you start talking to your lender about your real estate investment loans, you’ll hear a lot of letters tossed around. Specifically, LTV and LTC.
Knowing what some of these acronyms mean and how they’ll impact your loan is important. LTV (loan-to-value) and LTC (loan-to-cost) are formulas used to determine the value of your investment properties and project costs. These “LTs” can help you secure the best financing options and real estate loans to cover projects like new construction and renovations.
Lenders use LTV and LTC to assess risk and determine the terms of your loan.
Let’s talk about what you need to know about LTV and LTC ratios and how they affect the financing options for your real estate portfolio.
Understanding LTV ratio
Let’s look first at the LTV ratio. Lenders calculate LTV by dividing the loan amount by the property’s appraised value. For example, if your property is valued at $200,000 and you want to take out a real estate loan for $150,000, the LTV ratio would be 75% (150,000/200,000).
Lenders like to use the LTV ratio to determine how risky a loan might be. A higher LTV ratio may indicate that you’re borrowing against a larger percentage of the property's value and may have less equity in the property.
This increases the lender's risk because if the loan defaults, the lender may not be able to recover the total amount of the loan by selling the property.
If you shop around, you’ll find out that lenders vary the maximum LTV ratio allowed based on the type of loan they’re offering and their risk tolerance. For example, conventional loans typically have a maximum LTV ratio of 80%.
A higher LTV ratio generally means higher interest rates, which can significantly impact your monthly loan payments – and cut into your profits and cash flow. However, a higher LTV may also mean a lower downpayment - allowing you to save capital reserves.
Understanding LTC ratio
The LTC ratio is used in real estate financing to evaluate the debt amount relative to the property's cost. The LTC ratio is similar to the LTV (Loan-to-Value), but instead of comparing the loan amount to the appraised value of the property, it compares the loan amount to the total cost of buying and renovating the property.
For example, if you need to borrow $800,000 to acquire a property, plus an additional $200,000 for renovations, the total cost of the project is valued at $1,000,000.
This is where the LTC ratio comes in because it is calculated by dividing the loan amount by the total cost of acquiring and fixing up the property.
If you take out a real estate loan for $700,000, the LTC ratio would be 70% ($700,000/$1,000,000).
The maximum LTC ratio that lenders will typically allow varies depending on the type of loan and other factors.
LTV vs. LTC: Knowing what to use for your investment property
So, which one is right for you, LTV or LTC? The short answer is that it depends.
Whether to use LTV or LTC depends on the type of real estate investment project, property, and loan type.
LTV is generally the way to go if you need a real estate loan to purchase or refinance an existing property with a clear appraisal value.
LTV can help you determine how much financing you’ll need or which loan will be best for you based on the appraisal value.
For a new construction or major renovation project, LTC is usually a good option. This is because the cost of land acquisition, construction, and related expenses can be significantly higher than the appraised value of the property once the project is complete.
LTC factors in the total cost of developing the project, not just the appraisal value. This can ensure that you have access to as much funding as possible to get the project off the ground and completed.
So LTV is generally used for existing properties, while LTC is used for new construction or major renovation projects. However, your lender’s choice will ultimately depend on various factors, like the specific details of the investment project and the property value.
Choosing the right type of investment loan can make all the difference. Consider a few other factors when shopping for a real estate loan:
Loan type
Many alternative real estate financing options are available, including fix and flip/bridge loans, hard money loans, cash-out refinancing, and DSCR loans.
Interest rate
The interest rate can greatly affect your monthly loan payments and overall profits. Compare interest rates from a variety of lenders and loan types to find the best rate.
Loan term
The length of the loan term can also impact your monthly payments and cash flow. Consider whether a longer or shorter loan term is best for your investment goals and portfolio.
Fees and closing costs
Lenders may charge fees and closing costs for originating a loan. Ask for all of the information about your loan upfront to compare these costs from different lenders and loan types to ensure you're getting the best deal.
Wrapping it up
Understanding the concepts of LTV and LTC ratios is crucial when it comes to securing the best financing options for your real estate investment projects. Knowing how these ratios are calculated and their impact on your loan terms and interest rates can help you make informed decisions about your investment portfolio.
While LTV is generally used for existing properties, LTC is a better option for new construction or major renovation projects. However, choosing the right real estate loan involves considering various factors, including loan type, interest rate, loan term, and fees and closing costs. By taking these factors into account, you can select the best loan that fits your investment goals and portfolio.