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Loan to Value (LTV)

Loan to Value (LTV)

What is Loan to Value?

You might have heard your lender talk about Loan to Value and that they're unwilling to lend if the loan to value ratio is too high. What is loan to value anyways?

Loan to Value is the ratio of the amount you're borrowing versus how much the underlying property is worth. If you have a high loan to value (LTV) ratio, it means you're borrowing more money and investing less cash into the property. If you have a low loan to value (LTV) ratio, it means you're borrowing less money and investing more cash into the property yourself.

How to calculate the Loan to Value Ratio?

Property investors can simply calculate the Loan to Value ratio using this formula:

\[ { Total \, amount \, borrowed \over Total \, appraised \, value } \]

Why do lenders care about this metric?

This ratio is one of the most important metrics in lending. The lender needs to know that there is sufficient buffer so that if the loan defaults, the home value will be able to make the lender whole.

In other words, the lender may use this ratio as a benchmark for the amount of risk they're willing to take. If the borrower decides to put up more of their own money, the lender takes less risk and the borrower may end up getting a relatively more favorable interest rate. If the borrower puts up less money (ie. have a high loan to value ratio), the lender takes on more risk and may ask for higher interest or a shorter duration.

It’s worth pointing out that a property financed with a high LTV can have negative cash flow if operating expenses are higher than expected or vacancy periods are longer.

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