Loan to Value (LTV) Ratio in Real Estate

Loan approval can depend on this simple math equation

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The loan-to-value or LTV ratio of a property is the percentage of the property's value that is mortgaged. You can get the LTV by dividing the mortgage amount by the lesser of either the appraised value or the selling price.

For example, a home's appraised value might be $300,000. There is or will be a $240,000 mortgage against the property. The loan-to-value ratio is 80 percent: $240,000 divided by $300,000 works out to .80.

Lenders use different requirements to determine whether a loan will be granted with a certain LTV. It's quite common for owner-occupied residences to get loans at LTVs of 80 percent.

LTV Ratios in Commercial Real Estate

Commercial real estate covers a diverse group of structure types and uses, as well as vacant land. Commercial property owners often need mortgages to construct buildings. Owners sometimes need financing to keep their buildings fully leased and in good condition after they're constructed.

Banks, private lenders, insurance companies, pension funds, and even the U.S. Small Business Administration offer commercial real estate loans that can bring deals to fruition, create business partners, and even help owners avoid foreclosure.

Loan-to-value ratios are used in commercial real estate as well, but lenders sometimes require LTVs lower than 80 percent when a property is intended to be an investment. LTV ratios are one of three primary ratios that commercial lenders typically use.

In this case, the market value of the property is often used based on a commercial appraisal, but as with residential properties, the purchase price will be used if that's less. You might apply for a mortgage of $600,000. The property appraises at $750,000. The mortgage divided by the appraisal amount works out to 80 percent, which should be sufficient to get you financing depending on the lender.

As a general rule, commercial lenders won't approve loans with LTVs of more than 80 percent, but some lenders offer non-conforming loan programs that will go higher. And, of course, a lower LTV ratio goes hand-in-hand with favorable loan terms and rates.

Conventional Lenders

A conventional commercial mortgage lender is one that makes loans that are not guaranteed by the government or by a government program. They're typically banks and credit unions. They might consider LTV ratios in the neighborhood of 75 percent for some investment properties, but most won't go higher than 65 percent if the property is "management intensive."

In other words, the borrower is going to be actively operating and managing the business. The building is not merely sitting there, passively appreciating. Management intensive properties can include motels, gas stations and service states, and bars and restaurants. They typically involve a higher potential for failure.

Government-Sponsored Lenders

Government-sponsored enterprises (GSEs) include government programs like Freddie Mac, Fannie Mae, or Ginnie Mae. They'll typically cap LTV ratios at 80 percent, but this can depend on the type of property you're financing. It's usually 80 percent for apartment loans, and GSEs don't usually lend on commercial investment properties.

Owner-Occupied Properties

Owner-occupied properties are those where the borrower's company is actually in residence. For example, you might buy an office complex and situate your own office front and center of the main entrance. These types of properties are sometimes privy to approval at higher LTV ratios, at least through the Small Business Association (SBA). The SBA will sometimes approve loans up to as much as 90 percent LTV.

It's important to keep in mind, however, that the SBA does not actually issue these loans. Rather, it guarantees them with local banks. And very young businesses—those less than three years old or so—won't qualify with that 90 percent LTV ratio. More likely, the lender will look for an LTV somewhere in the neighborhood of 65 percent in this case.

Second Mortgages

If you're applying for a second mortgage—you already have a first mortgage against the property but you're looking for additional operating capital for a period of time—you would add the two mortgages together before dividing by the appraised value.

As a practical matter, however, GSEs virtually never allow second mortgages behind their first mortgage positions, nor will most conventional mortgage lenders.