Formula & How To Calculate

The loan-to-cost (LTC) ratio is the relative comparison between the loan amount of a commercial mortgage and the total cost of a rehabilitation or construction project. The LTC ratio helps investors determine the riskiness of commercial real estate investments. It’s used primarily for two types of commercial mortgages: rehabilitation loans and construction loans. The higher the LTC ratio, the more debt taken as part of the project, which makes the project riskier.

You can use the LTC ratio to determine the viability of a rehabilitation or construction project— and to determine if the total costs will allow you to make a profit at the project’s conclusion.

Loan-to-Cost (LTC) Ratio Formula

Calculate the loan-to-cost ratio with a simple formula: take the loan amount and divide it by the total project cost, which includes acquisition, construction, and renovation costs.

The LTC formula is:

LTC = loan amount / total project cost

The result of the calculation is then expressed in a percentage.

  • Example 1: You have borrowed $150,000 to complete a project. The property was acquired for $140,000 with $60,000 of renovation costs. In this case, LTC = $150,000 / $200,000 = 75%. In this case, the LTC would be acceptable for a construction or fix-and-flip loan.
  • Example 2: You would like to borrow $200,000 to complete a project. The property is priced at $100,000 with $50,000 of renovation costs. In this case, LTC = $200,000 / $150,000 = 133%. In this case, you won’t be able to borrow the full amount of $200,000 because the LTC is greater than 100%. You would likely have to put your own cash into the project and take out a smaller loan.

Why the Loan-to-cost Ratio Is Important

The loan-to-cost ratio allows borrowers to calculate the amount they need to contribute to complete a construction or renovation project. Once the lender sets the allowable LTC, they can use the LTC to see how close they’re to the lender requirement and how much they’ll have to fund to make the loan work for underwriting.

Three types of borrowers need to consider the LTC ratio as part of the application process:

  • Fix-and-flip borrowers: Borrowers use these loans to purchase, rehabilitate, and sell a property within 12 to 18 months.
  • Renovate-to-permanent borrowers: These are similar to fix-and-flip borrowers, but rather than selling the property, the borrower converts the short-term loan into permanent financing to use the property for rental income.
  • New construction borrowers: In this case, the costs involved with the ground-up construction are compared to the loan amount to determine the LTC involved with a new build.

The lender will set a maximum LTC value (often 75%), which will let borrowers know the high-end limit of their loan. To calculate the maximum loan amount needed, just change around the formula above to solve for the loan amount:

Loan amount = maximum LTC x total project costs

  • Example: If the total project costs will be $200,000, and the lender has set a 75% maximum LTC, the amount the borrower can borrow = $200,000 x .75 = $150,000.

Difference Between LTC Ratio, ARV, and LTV Ratio

While the loan-to-cost ratio, loan-to-value ratio (LTV), and after repair value (ARV) are useful as part of a mortgage loan, they are used in very different situations.

In general, the LTC and ARV ratios are used when something more than the acquisition cost of the property needs to be considered, as is usually the case with construction or rehabilitation projects.

If you buy commercial real estate or a residential investment property and have no plans to rehab the property, then the LTV ratio will be considered. With no planned improvements, the appraised value represents the property’s accurate value both before and after the purchase.

Bottom Line

The loan-to-cost ratio compares the total cost of a construction or renovation project to the loan amount borrowed. The lender will set a maximum LTC (usually 75%), which will let the borrower know exactly how large a loan they can qualify for based on the total project costs. As you’re planning your project, it’s important to understand what your lender’s maximum LTC is so you can accurately estimate the loan size. This’ll allow you to know how much of your own money you’ll need to complete a project.

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