Can somebody please explain Loan to Value and incorporate some numbers in an example format?
Thanks
Loan to Value (LTV) is basically the amount you borrow compared to the value of the property.
So, if you find a desperate landlord and buy his property that has a market value of $100,000 for $50,000, then the LTV is 50% ($50,000/$100,000).
Good Luck,
Mike
Mike gave you a correct definition but his example is really purchasing for 50 cents on the dollar. If you needed financing to buy this property, and a lender will only give you an 80% LTV loan, then the loan amount will be $40K, or, 80% of the $50K purchase price.
When talking to a lender about financing a property you want to purchase, Loan to Value is the ratio of the loan amount to the purchase price, or to appraised value whichever is less.
Let’s say you get a property under contract for $50K. The appraisal the lender ordered comes in at $63K. If you put $5K down and finance $45K, the LTV is 90% and the lender will require PMI. Makes no difference that the loan is just 71% of the appraised value. In the lender’s eyes, you used 90% financing to purchase the property and they require PMI for any loan with an LTV greater than 80%.
Dave T,
While I agree with you that lenders will often only loan some percentage of purchase price or appraised value, whichever is lower, that does not change the definition of LTV. Loan to Value is defined as a ratio of the amount borrowed to the (appraised) value of the property. Purchase price is not part of the equation.
In addition, while many banks will only loan a percentage of purchase price or appraised value, whichever is lower - that is certainly not universally true. I have purchased the majority of my properties with 100% financing, but with a low LTV.
Which situation gives the bank a better collateral position?
- Loaning an investor 80% of a $100,000 purchase price of a property with an appraised value of $100,000 (80% LTV, with $20,000 equity)
or
- Loaning an investor 100% of a $50,000 purchase price of the same property with an appraised value of $100,000 (50% LTV, with $50,000 equity).
Obviously, the bank is in a much safer position loaning 100% of the $50,000 purchase price when the house is worth $100,000!!!
Mike
Mike,
I did agree with you that the definition of LTV is the ratio of the loan amount to the value of the property. Your $50K purchase price example did not mention any amount of financing, so your example was not really an LTV example but rather an example of purchasing for 50 cents on the dollar. You might have paid all cash or partially financed the purchase but you did not specify. So the example you used, as you stated it, was flawed. In my earlier explanation, I was also at fault for not specifying that my examples were in the context of residential mortgage financing.
It is important to point out that lenders don’t always define “value” the way you do.
Residential mortgage lenders define “value” as the lesser of purchase price or appraised value for a purchase money loan. If you are getting 100% financing for a property you are purchasing for 50 cents on the dollar, then the residential mortgage lender is giving you a 100% LTV loan. No matter how much you argue that your loan is really 50% of the appraised value, the lender will still require PMI. Now, if you want to refinance that loan, even the residential mortgage lender will disregard the purchase price and use a value equal to the as-is appraisal when making their LTV calculations.
In your business model, I believe you use commercial financing and purchase your properties in the name of your business entity. I don’t argue that the LTV for a commercial loan may be based on a definition of value that is equal to the as-is appraisal and I don’t doubt that you have found commercial lenders that will give you 100% financing for your investment purchases.
I am simply recognizing that this question is most likely coming from a beginning investor who is probably considering his first purchase. Perhaps that purchase will be his primary residence. This individual will most likely be dealing with residential mortgage lenders and their LTV rules.
If your book doesn’t discuss the difference in the application of LTV for residential and commercial loans then I will be happy to write a section on this for you if you want to include it in your book. Send me a copy and I will have something for you in a couple of days.
Dave,
You are right, my first post was incomplete. I should have pointed out that I was assuming the investor financed 100% of the $50,000 purchase price for a property appraised at $100,000.
I also agree with everything else you said and you are correct, I almost always use commercial loans and all my properties are purchased by businesses (usually LLCs). I also agree that most residential lenders want to loan a percentage of the lesser of appraised value or purchase price. Another great reason to run a separate business and borrow the money with the business (usually requiring a personal guarantee).
Mike
GREAT DISCUSSION guys!!! It made me understand why LTV is often different depending on when/how it is used. Thanks.
Jay