What is a loan to value ratio and why is it so important when getting a hard money loan?
That is a question that we get asked often. LTV is important to us, as well to our investors. Let’s start out first with how to calculate LTV. It really is pretty simple. You take the amount of your loan and divide it by the total value of your home.
So let’s say for example that you are buying an investment property worth $100,000. You have $20,000 for a down payment. That means that you will need a hard money loan for $80,000. What then is your LTV? You will simply calculate 80,000/100,000 = 0.80. (Loan Amount/Home Value=LTV). Your LTV is 80%!
It is important to note that the home value is not what you are purchasing the house for or what the house was listed for on the market. The home value is the appraised or current market value.
The higher the LTV, the higher the risk for the loan, thus the investor will have to lend larger sums of money. This is usually due to the fact that borrowers with high LTV properties have less invested in that property. Take the above example, if you only have $20,000 of your own money invested in a property you are more likely to just walk away if financial crisis hits. However, if you have $50,000 invested, making your LTV 50%, you are less likely to walk away. It’s all about how much “skin you have in the game”.
All investors lend their money in good faith that you will pay your loan as agreed. However in those rare cases that doesn’t happen the investor wants to be able to recover their money plus any legal/administrative fees incurred during the process of trying to do so.
The real estate market fluctuates. Home values go up and home values go down. There is no way to 100% accurately predict what the market is going to do. Therefore, the lower the LTV the more likely the investor can sell the securing collateral for the loan amount or more even with the fluctuating real estate market.
So there you have it. A quick and simple explanation of what a loan to value ratio is and why it is important when getting a hard money loan!