Importance of Loan-To-Value Ratio in Commercial Loan

David Cohn
Nov 8, 2020
Market Value

The loan-to-value ratio compares the value of that commercial real estate asset you want to buy and the amount of money you intend to borrow. It is particularly important when you want to take out a loan.

Commercial mortgage lenders would typically refer to that ratio to determine if they will approve your application or not.

It is also their basis when determining how much money they can lend and at what interest rate.

Knowing how to calculate and reduce your loan-to-value ratio could make it easier and more affordable for you to get the commercial loan you need for your property or upcoming project.

Calculating your LTV ratio

It’s easy to calculate the loan-to-value ratio once you are aware of the numbers to use. The basic formula is simple: Divide the amount of money you want to borrow by the asset's appraised value.

You will be able to get a value that you can then convert into a percentage.

So, if you are taking a $200,000 mortgage for a property with a $250,000 appraisal, that’s 200,000 divided by 250,000, which will give you 0.80. The LTV ratio is, therefore, 80 percent.

You will pay a $50,000 down payment out of pocket.

Matters can get tricky when lenders use the asset’s appraised value, potentially different from its selling price.

Using the example earlier, if the property owner is desperate to sell and agrees on a $225,000 selling price, you will be spending less money on the down payment if you borrow $200,000.

The LTV will be the same because the appraised value and loan amount are unchanged.

However, the LTV ratio may change after your purchase as you start paying down the loan and the property’s appraised value changes (rises or falls).

The current LTV is important because it affects your ability to take out additional loans against the asset or refinance the mortgage.

Determining the best loan-to-value ratio

The lower your LTV, the better chances you have of getting approved for a loan. That said, a “good” loan-to-value ratio depends on the type of loan you intend to get and the lender you are working with.

For conventional mortgage lenders, a minimum of either 95 or 97 percent is required, but the best LTV on a conventional loan must be around 80 percent or lower.

This way, the lender perceives it as low risk, and it is likely to approve the commercial loan application.

Typically, high LTV ratios on loan assessments are considered high-risk loans; even if the loan is approved, the interest rate is likely to be higher, and you may need to purchase insurance to offset the lender’s risk.

Ways to reduce your loan-to-value ratio

The value of the asset and the loan amount are the only two moving aspects in the formula to determine the loan-to-value ratio.

So as you take out the loan, you can potentially reduce the LTV by making a bigger down payment or using that down payment to purchase a less expensive property.

From there, the loan-to-value should decrease as you keep repaying the loan over time.

It’s also important to keep tracking your LTV, especially if you got a loan with less than a 20 percent down payment (which means an LTV was exceeding 80 percent and you are paying for loan insurance).

Lenders are looking beyond the LTV.

Despite the importance of the lender's loan-to-value ratio, it is merely a piece of a larger puzzle.

A lender will also look into other factors to determine your eligibility for a loan and the rates, terms, and amount you can receive.

Those are:

Your income history:

Lenders would want to know that you will have the means to repay the loan over time, so they might ask to see your recent earnings and paychecks, tax returns, W-2s, and other documents to verify your income.

If you have had a steady flow of income for at least two years from employment, that’s favorable to the lender.

You may also qualify if you have been working in the same industry, and your income has increased, even if you change jobs or specializations.

Your credit: Lenders can gauge how likely you are to miss payments by checking your credit score and history.

Many of them impose minimum credit score requirements. If your score is less than stellar, your interest rate, down payment, and loan amount may be negatively impacted.

So even with a low loan-to-value ratio, you still may not get approved if you have poor credit.

Debt-to-income (DTI) ratio:

The DTI ratio shows how your monthly income fares against your monthly financial obligations, such as loan payments, other debts, rent, etc.

Lenders want to see a lower DTI, as it shows that only a small amount of your income is going to those payments—which means you have more money to pay for your loan.

A DTI that is under 36 to 43 percent is favorable, but the range could depend on the kind of loan you are taking out.

How your loan-to-value ratio impacts interest rates?

Lenders follow ‘risk-based pricing,’ a practice where they set higher interest rates on the loans they think are relatively risky. If you have abysmal credit, you are likely to be charged more.

The practice is applied to LTV, too, as a high ratio means a high risk for lenders. You can expect high-interest rates with high LTVs.

The bottom line

Your down payment and loan-to-value ratio are both critical factors when you want to purchase commercial property. Your LTV decreases when you can put down more money.

You can refer to the LTV calculation to determine how much you can afford to purchase, as most loans would typically require at least a 3 percent down payment and a 97 percent LTV.

By putting 20 percent down, you can potentially save money.

A lender may also provide a lower interest rate because they feel that they are taking less risk with you, and they may also provide lower monthly payments when you borrow less money.

Get help from commercial real estate investment specialists.

Should you need any help in getting any commercial real estate loan, don’t hesitate to contact Capital Investors Direct.

We are an investment advisory firm specializing in commercial real estate, based in Rockville, Maryland.

Through us, you can find customized loan solutions, which may be unavailable through conventional banks.

We are known for our fast closing, low-interest rates (at least 7 percent), highly customized loan structures, and our simple application process.

Capital Investors Direct is also able to finance commercial real estate projects of every size.

Our commercial real estate loan solutions are delivered per the objectives and goals of investors and lenders while maintaining your best interests.

By applying an investment-specific approach, we can customize our commercial loan solutions to the needs of every client.

We also apply the latest and proven finance technology to give you access to a wide array of investment solutions.

You can rely on us whether you require hard money, bridge loans, jumbo loan, construction loans, permanent loans, or stated income loans.

We understand that every client is unique; that’s why our team consists of qualified commercial real estate placement professionals who seek to understand your unique requirements and circumstances.