What Is An LTV Ratio For Commercial Real Estate?

When applying for a small business loan or upgrading or purchasing real estate, you’ve likely encountered the term LTV ratio through your lender.

LTV (or Loan-To-Value) ratio plays a big role in getting your loan approved. In this post, we’ll explore what it means, how it’s calculated, and other information you need to know before making your commercial real estate purchase.

What Is A Loan-To-Value Ratio?

An LTV ratio is a number that represents the potential risk of a loan to the lender. This ratio is a percentage, and the higher the number, the greater the perceived risk to the lender.

When referencing a mortgage, it calculates the amount of debt versus the value of the property being mortgaged and assesses risk based on that number.

You’ll most commonly see an LTV ratio used in hard money loans, but banks also look at this ratio when calculating mortgages.

How Is The LTV Ratio Calculated?

The LTV ratio is one of the simplest financial calculations:

Amount Borrowed / Value Of The Property = LTV

As the percentage increases, the lender takes on more risk.

If a lender finances 100% of the property value, they are providing full financing. High LTV ratio loans are typically only offered to borrowers with excellent credit.

Here’s an example: You take out a $100,000 loan on a piece of property estimated to be worth $140,000. Using the formula above, you determine that $100,000 / $140,000 = 0.7142. Your LTV ratio would be 71%.

Why Are Loan-To-Value Ratios Important To Lenders?

Hard money lenders use LTV ratios to assess risk just like more traditional lending institutions. There are some small differences in how they use it, however. Because of the higher risk involved with hard money lending, the lenders have to consider the strong possibility that the borrower will default.

Whereas banks might heavily factor credit into their calculations along with LTV, hard money lenders value LTV substantially more than credit. Some lenders may not care about credit at all. As a counterbalance, they use the equity the borrower puts into the property as a security. Effectively, this means hard money lenders will, in most cases, look for a lower LTV than a bank would.

What Is A Good Loan-To-Value Ratio?

This question can be broken down into simpler terms: how much are lenders willing to cover?

In addition to any background checks the hard money lender may decide to factor in, the property’s qualities will be considered.

Properties in booming real estate markets and “up-and-coming” neighborhoods may push the lender’s LTV tolerance close to 75%, often considered the upper limit for hard money. In contrast, a property in a poor market or a remote one will push the maximum LTV closer to zero.

Similarly, the state of the property will play a large role in how much risk the hard money lender is willing to take on. The better the state of the property, the higher the LTV can go.

Where Can I Get The Best Real Estate Loan?

Start your search with the best commercial real estate loans. These options provide low interest rates, long repayment terms, and high borrowing limits.

You can also consider getting an SBA loan. Similar to traditional loans, you’ll have access to high borrowing limits, competitive rates, and long repayment terms.

The best options are 7(a) loans and 504 loans. There are different pros and cons to each, so do your research before deciding which to apply for, starting with a head-to-head comparison of 7(a) and 504 loans.

Final Thoughts On LTV Ratios

It’s always a good idea to try and understand how your lender is making their underwriting decisions so you know you’re getting a good deal.

Fortunately, you will eventually see your LTV ratio in the form of the amount of money they offer you in the end, so it isn’t worth stressing too much over.

The most important thing to remember is that the more the lender is willing to cover, the higher they’ve assessed the value of the property.

Hopefully, this overview has given you a basic understanding of what LTV is and how it’s used in real estate transactions. Next, we recommend checking out our article on commercial real estate loans to learn more about the different types, rates, and requirements you may encounter when purchasing property for your business.