Underwriting Hard Money Loans: Loan to Cost vs. Loan to Value
When underwriting a hard money loan, the lender can focus on the Loan to Cost (LTC) or the Loan to Value (LTV). Some may prioritize one of these ratios in all cases while others may choose to select one over the other in different circumstances.
In this article, I will outline how we view LTC vs. LTV at Conventus. I hope it is helpful to anyone interested in learning how lenders approach risk.
1. What are Day 1 LTC and LTV?
Let’s say a real estate investor buys a property for $1M, but the property is appraised to be worth $1.1M. The borrower may go to a lender and request a loan of $800K.
The Day 1 LTC would be 80% ($800K/$1M), whereas the Day 1 LTV would be 72.7% ($800K/$1.1M).
The definitions of Day 1 LTC and LTV are below.
● Day 1 LTC: the loan amount divided by the total cost of the project to date
● Day 1 LTV: the loan amount divided by the total as-is value of the property
2. What are Day Done LTC and LTV?
In the scenario above, let’s say the real estate investor plans to put in $50K of their own money to add value to the $1M property. They expect the property will be worth $1.3M when the rehab is completed.
The Day Done LTC would be 76.2% ($800K/$1.05M), whereas the Day Done LTV would be 61.5% ($800K/$1.3M).
If the borrower financed the $50K rehab, the numbers would be as follows instead:
● Day Done LTC: 81% ($850K/$1.05M)
● Day Done LTV: 65.4% ($850K/$1.3M)
The definitions of Day Done LTC and LTV are below.
● Day Done LTC: the loan amount divided by the total cost of the project when completed
● Day Done LTV: the loan amount divided by the total after repair value of the property
3. Why we prioritize LTC
As can be seen above, the difference between LTC and LTV is LTC is focused on the cost of the project while LTV is centered on the value of the property.
In most situations, we care more about LTC than LTV. LTC reflects the borrower’s skin in the game, and our top priority is to protect our capital. As such, we focus on originating loans where we know the borrower has some equity in the project.
In particular, it is crucial for us to focus on LTC for construction completion loans. In these situations where the project is less than 95% complete, it will be difficult for an appraiser to determine the as-is value. They will not have any comps to use. As such, we rely on LTC to figure out what loan amount to give the borrower.
That said, we still keep LTV into account. If the borrower puts in $1M of work into a property and it appraises at $800K, we will figure out the discrepancy and ensure the loan amount still makes sense.
4. When do we focus on LTV?
When a project is 95% or more completed, we will focus on LTV if we are doing a refinance. The loan will be less risky because the property is ready for sale and the borrower will have no incentive to walk away. If we did need to foreclose, however, we would list the property with a safe margin because the LTV for refinances is lower than it is for purchases.
Overall, I hope this article helps to explain how we underwrite loans and how our guidelines match our business model to protect our capital first and make a profit second. We believe that strategy allows us to be aggressive on pricing and establish long-term relationships with our borrowers.
Loan to Cost and Loan to Value are always at the top of our minds. Please reach out if you have any loans you would like to discuss.
by Jared Newman | jared@cvlending.com
Jared is a Loan Officer for the hard money lender Conventus, LLC and has been working in real estate since 2016. He is about to start an investment portfolio of his own with rental properties
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