How to Calculate Loan to Value Ratio (LTV)
The loan to value ratio (LTV) is a fundamental measure of risk in the commercial real estate market, most often used as part of loan sizing by lenders.
The loan to value ratio (LTV) is an underwriting metric frequently measured by financial institutions, such as banks and institutional lenders, to analyze credit risk, particularly when performing due diligence on residential and commercial mortgage applications.
The LTV ratio compares the size of a requested loan to the appraised value of the property securing the financing.
To elaborate, the underlying property pledged as collateral on which the lender possesses a lien can be seized in the event of default.
Commercial lenders frequently compare the total dollar value of the proposed loan to the percent contribution of the borrower (i.e. the equity investment), including the fair market value (FMV) of the property securing the loan.
The higher the down payment contributed by the real estate investor or home buyer, the lower the loan-to-value ratio (LTV) – all else being equal.
Generally, a “good” loan-to-value ratio (LTV) is perceived to be around 65% to 80% in the commercial real estate (CRE) market.
However, the prevailing economic conditions and cyclicality in market demand, among other external factors, can cause the target range to fluctuate.
But for the more risk-averse commercial real estate (CRE) lenders, the standard maximum loan-to-value ratio (LTV) is around 75%, which functions as a constraint to limit the loan size (i.e. upper parameter) and mitigate the risk of their lending portfolio.
The loan-to-value ratio (LTV) measures the relationship between two factors relevant to lenders from a risk standpoint.
Secured Loan Amount ➝ The total amount of debt capital provided by the lender as part of the financing arrangement.
Appraised Value of Pledged Asset ➝ The appraised fair value of the secured asset, such as a property, as of the current date.
Loan to Value Formula
The loan to value ratio (LTV) formula divides the loan amount by the appraised property value.
Loan to Value Ratio (LTV) = Loan Amount ÷ Appraised Property Value
Where:
Loan Amount → The total size of the loan provided by the lender, or the amount requested by the borrower.
Appraised Property Value → The estimated fair market value (FMV) of the property on the present date.
Conversely, the property value can be switched out with the purchase price, assuming the variance between the two is marginal.
Since the loan to value ratio (LTV) is expressed as a percentage, the resulting figure should then be multiplied by 100.
