What is LTV in Real Estate?

What is LTV?

The Loan-to-Value (LTV) ratio in real estate is a measure used by lenders to assess the risk of a mortgage, calculated by dividing the loan amount by the property's value and expressing it as a percentage. A higher LTV ratio signifies greater risk to the lender, often leading to stricter loan terms, higher interest rates, or the need for mortgage insurance. LTV is essential in determining borrowing capacity, impacting both new mortgages and refinancing scenarios.

Here's how it works:

1. Calculation: LTV is calculated by dividing the amount of the loan by the appraised value or purchase price of the property, whichever is lower. The result is expressed as a percentage. LTV = (Loan Amount x Property Value) × 100%‍
2. Risk Assessment: A higher LTV ratio means more risk for the lender. If the LTV ratio is high, it indicates that the loan amount is close to the property's value, reducing the lender's security if the borrower defaults.‍
3. Impact on Borrowing: Lenders typically prefer a lower LTV ratio (usually 80% or less) as it implies a lower risk. A higher LTV ratio might require the borrower to purchase mortgage insurance, which protects the lender in case of default.‍
4. In Refinancing and Second Mortgages: LTV is also important when refinancing a property or taking out a second mortgage. It helps determine how much additional money can be borrowed against the property's equity.‍
5. Real Estate Market Influence: The LTV ratio can be affected by changes in the real estate market. If property values decrease, the LTV ratio can increase even if the loan amount remains the same.

LTV is a key indicator of the financial health of a real estate investment or transaction.

Using LTV to Size a Multifamily Loan

• Property Value (Appraised): $10 million
• Maximum LTV allowed by lender: 75%
• Net Operating Income (NOI): $700,000 annually
• Interest Rate: 5.5%
• Amortization Period: 30 years
• Debt Service Coverage Ratio (DSCR) requirement: 1.25x

Step 1: Determine Maximum Loan Amount Based on LTV

Lenders typically use the LTV to cap the loan amount. Here, the lender has a maximum LTV of 75%.

• Maximum Loan Amount = Property Value × LTV

So, based on the LTV, the lender is willing to provide a loan of up to $7.5 million.

Step 2: Calculate Debt Service for Maximum Loan

Next, we calculate the annual debt service (loan payments) on the $7.5 million loan using the interest rate and amortization period.

We use a standard mortgage payment formula or an online calculator for a 30-year loan at 5.5% interest.

• Annual Debt Service for $7.5 million loan at 5.5% interest = $512,500 per year

Step 3: Check DSCR Requirement

Lenders also require the property to generate enough income to cover the debt payments. This is where the Debt Service Coverage Ratio (DSCR) comes in. DSCR is calculated as:

• NOI: $700,000
• Annual Debt Service: $512,500

The DSCR in this case is 1.37x, which is above the lender's required minimum of 1.25x. This means the property generates sufficient income to comfortably cover the debt payments.

Step 4: Borrower's Equity Contribution

With a $7.5 million loan and a property value of $10 million, the borrower needs to contribute the difference as equity.

Deal Overview

• Property Value: $10 million
• Maximum Loan Amount: $7.5 million (based on 75% LTV)
• Annual Debt Service: $512,500
• NOI: $700,000
• DSCR: 1.37x (meets the lender’s requirement of 1.25x)
• Borrower’s Equity Contribution: $2.5 million

In this example, the borrower can secure a $7.5 million loan, as it meets both the LTV and DSCR requirements, and the borrower would need to invest $2.5 million in equity for the deal to proceed.