Loan To cost v. Loan to value

  • Definitions of Loan to Cost and Loan to Value
  • How lenders evaluate each metric
  • What is best for your investment strategy?

Loan to Cost v. loan to value

Loan to Cost Definition – loan to cost, or LTC, is a metric in commercial real estate that measures the ratio between the total loan amount and ‘cost’ of the project.  Cost is either used as construction cost or purchase price.  For example, the loan to cost of a $10,000 construction project with a $7,000 loan is 70% LTC ($7,000 divided by $10,000).  Similarly, a burrower who wants $40,000 hard money loan to purchase a property that costs $45,000 will have a loan to cost of 88.8%.  

Loan to Value Definition – loan to value, or LTV, is a metric in commercial real estate that measures the ratio between the total loan amount and fair market value of the project.  For example, a loan to value of a building worth $200,000 and a loan of $150,000 has an LTV of 75% ($150,000 divided by $200,000).

Lenders use both metrics to measure risk – the higher the percentage the higher the risk to the lender.  If a property is purchased at 60% LTV, it is safer than 80% LTV, because the burrower has injected more equity (cash) to the purchase price, indicated better financial strength.  

Loan to cost and loan to value indicate a level of risk to the lender – a higher percentage indicates a greater risk because the burrower has less equity interest in the project.  

When comparing loan to cost and loan to value, you need to ask yourself what is better suited to measure your investment.  If you are trying to evaluate a construction project – LTC is a better measure because you need to consider construction costs and the finance requirement to see if the project is viable.  When purchasing a turn-key asset, LTV is a better measure because in all likelihood –  the fair market value is close to the purchase price.

Loan to cost is can also be used when certain deals require immediate cash infusion at close of escrow or right away.  For example – purchasing a distressed office building using a hard money loan and paying off a couple of liens to clear title.  In this example, the office building is being purchased for $300,000, and in order to finalize the deal, the buyer agreed to pay a total of $15,000 to a contractor who holds 2 mechanic’s liens for unpaid work.  The $15,000 is not part of the purchase price, but it is part of the total cost.  Therefore, in order to get the true cost to own, LTC is used for a better measure of risk in this case.

Before entering a new project, you need to incorporate these risk factors into your business plan.  And by understanding the concepts of LTV and LTC – you can better navigate the hard money lending process.

When considering risk loan factors, lenders will use LTV and LTC to underwrite a deal.  So when does the difference between them and why you should use one or the other?

The key difference comes into play when you purchase a property for a steep discount.  For example, consider the following case study of a request for a hard money loan on a mobile home park

Property A is purchased for $100,000, but it has a fair market value of $150,000.  A loan for $90,000 for the purchase represents a 90% loan to cost, which most lenders will avoid – it represents high risk since the burrower does not contribute enough capital of his own.  But when using loan to value, a lender might get a different picture.  LTV for this property A is 60% – a much more reasonable risk level for lenders.  

Framing the deal around loan to value falls under the risk parameters most lenders are looking for – which could represent a lower risk profile than a high loan to cost.

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Loan to Cost

The big difference between LTV and LTC comes into play in fix and flip loans – when the final fair market value of the property is higher than the purchase cost (hopefully this is the case).  Real estate professionals who come to us for a fix and flip hard money loan need not just funds to close the deal, they also need to make sure they have enough capital to renovate and market the property for sale.  

On numbers alone, loan to cost ratio will be well above 65% in almost any fix and flip hard money loan, indicating high risk that most lenders would want to avoid.  But when analyzing the project from a loan to value perspective, the numbers change and makes more sense – since the final value of the project is expected to be higher than the purchase price.

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