How to Calculate Loan-To-Value Ratio in Commercial Real Estate

Real estate agent talking to clients and explaining the loan to value on the mortgage.
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When you apply for a mortgage on commercial or investment property, one of the factors that lenders will look at is the loan-to-value ratio or LTV. This ratio describes how much of the value of the property the mortgage covers and allows lenders to determine how much risk they are taking on by offering a mortgage.

It is expressed as a percentage and is calculated by dividing the mortgage amount by the lesser of the selling price or appraised value. A higher down payment creates a lower LTV ratio and indicates less likelihood of foreclosure.

A lower LTV ratio usually results in more favorable loan terms and interest rates.

How to Calculate Loan to Value Ratio

To calculate the LTV, start with either the selling price or the appraised value of the property. Determine the down payment you have available, then subtract that from the selling price to find the mortgage amount you need. The loan-to-value ratio is the mortgage divided by the lower of the selling price or the appraised value.

LTV = [price - down payment] / price

If a property is selling at $300,000 and you have $40,000 available for a down payment, then the mortgage you need is calculated by:

$300,000 - $40,000 = $260,000 desired mortgage

Divide the mortgage amount by the selling price and convert the result to a percentage to derive the LTV ratio:

$260,000 / $300,000 = 0.87 or 87%, which is the LTV ratio.

Although you may be buying a property below the appraised value and consider it a bargain, the lender will use the lower purchase price in this calculation, which will make your LTV higher.

Types of Mortgages That Use the LTV to Qualify Borrowers

The loan to value ratio is used to qualify borrowers, though it is just one of many different factors that may be considered. There are different choices for mortgages, and the type of mortgage you are seeking, along with the interest rate and payment, will be a part of both your decision and the lender's offer.

1. Fixed-Rate Mortgage

This is the basic mortgage with an equal payment every month until it is fully paid off. The simple P & I payment is made up of two components: principal and interest. As the loan is paid down, the portion of your payment that goes toward interest goes down each month and the amount that pays off the principal goes up, adding to the equity in the property.

The most popular mortgage type is the 30-year fixed-rate mortgage, followed by the 15-year fixed-rate loan. The 15-year mortgage pays off in half the time with higher payments and a lot less interest paid over the lifespan of the loan. In either case, whether interest rates go down over the course of your loan term, you are always locked into the same rate.

2. Adjustable-Rate Mortgage

An adjustable-rate mortgage (ARM) is a loan with an interest rate that changes. ARMs may start with lower monthly payments than fixed-rate mortgages and are often a gamble that interest rates will stay low. However, they have risks such as:

  • Unpredictable changes in monthly payments
  • Increases in monthly payments even if interest rates don’t go up
  • Payments not decreasing even if interest rates do
  • Penalties for early payment
  • Owing more money than you borrowed, even if you make payments on time

3. Blanket Mortgage

If you are an investor and own multiple properties with equity, you may be eligible for a blanket mortgage. This allows you to open a line of credit with a bank or get a loan by allowing the lender to use one of your other properties as collateral. Both properties are covered by the mortgage, but you can sell one while still keeping the mortgage on the second. 

Loan to Value Ratio Needed for Investment Property

Lenders will allow different LTV ratios based on the type of property for which you are seeking a mortgage. Mortgages for investment properties usually require lower LTVs to minimize the risk of foreclosure.

Rental or vacation properties are generally treated more like investment properties since they are not full-time residences for the person seeking the mortgage.

Commercial lenders are more likely to approve loans with an LTV lower than 80 percent.

Mortgages for commercial properties, like office buildings or apartment complexes, have a different set of underwriting criteria than residences or single-family homes. These loans are often based more on the projected income stream of the property, such as its rental history or the commercial potential of the area in which it is located, than on factors like the credit history of the owner.

In these, cases, however, the LTV may still be considered, as it gives a picture of how much risk the lender is taking on by offering a mortgage.

Article Sources

  1. Consumer Financial Protection Bureau. "What Is a Loan-to-Value Ratio and How Does It Relate to My Costs?" Accessed Jan. 23, 2020.

  2. Office of the Comptroller of the Currency. "Loss Given Default of High Loan-to-Value Residential Mortgages." Accessed Jan. 23, 2020.

  3. Federal Reserve System. "Frequently Asked Questions on Residential Tract Development Lending." Accessed Jan. 23, 2020.

  4. Office of the Comptroller of the Currency. "Comptroller's Handbook: Commercial Real Estate Lending." p. 123. Accessed Jan. 23, 2020.

  5. Federal Deposit Insurance Corporation. "Rules and Regulations: PART 365—REAL ESTATE LENDING STANDARDS." Accessed Jan. 23, 2020.

  6. Federal Deposit Insurance Corporation. "Fixed Rate and Adjustable Rate Mortgages." Accessed Jan. 23, 2020.

  7. Consumer Financial Protection Bureau. "What Is the Difference Between a Fixed-Rate and Adjustable-Rate Mortgage (ARM) Loan?" Accessed Jan. 23, 2020.

  8. United States Census Bureau. "Glossary Of RFS Terms And Definitions." Accessed Jan. 23, 2020.

  9. Office of the Comptroller of the Currency. "Comptroller's Handbook: Commercial Real Estate Lending." p. 72-74. Accessed Jan. 23, 2020.