The loan-to-value (LTV) ratio compares your loan amount against the value of the collateral it is being secured by. Lenders use this to determine your loan eligibility and the specific rates and terms you’ll get.
Loan-to-Value (LTV) Ratio: What It Is & How to Calculate It
This article is part of a larger series on Business Financing.
The LTV ratio is a common requirement for secured loans, such as real estate, equipment financing, and vehicle loans. A good LTV ratio is usually 80% or less. However, the requirements can vary depending on the specific type of loan you’re applying for, the lender you choose, and the strength of your credit and finances.
If you’re having trouble getting qualified, working with a company like Lendio can be helpful. It is a broker with over 75 lending partners, and its dedicated advisors can help match you with the right financing option.
Loan-to-Value Ratio: Formula & Example
The LTV ratio can be calculated by using the following formula:
Loan to value | = | Loan amount |
Value of the loan’s collateral |
Example of How to Calculate LTV
Regardless of the type of loan you’re applying for, LTV is calculated in the same manner. Below are some examples of how LTV would be calculated:
Real Estate Loan | Equipment Loan | Vehicle Loan | |
|---|---|---|---|
Loan Amount | $500,000 | $250,000 | $55,000 |
Value of Collateral | $1.2 million appraised value of home | $400,000 purchase price of equipment | $60,000 purchase price of equipment |
LTV Calculation | $500,000 ÷ $1.2 million = 41.67% (LTV) | $250,000 ÷ $400,000 = 62.5% (LTV) | $55,000 ÷ $60,000 = 91.67% (LTV) |
Combined Loan-to-Value (CLTV) Ratio: Formula & Example
LTV is used when only a single loan applies to secured financing. When multiple loans are involved, however, a calculation for CLTV can be applied.
The CLTV ratio is calculated by taking the sum of all loans and then dividing it by the value of the collateral it’s secured by.
Combined Loan-to-Value | = | Sum of all loans |
Appraised value of property (or other collateral used for the loan) |
Example of How to Calculate CLTV
Below is an example of how the CLTV ratio would be calculated for a real estate loan:
Real Estate Loan Example | |
|---|---|
Existing First Mortgage | $150,000 |
Existing Second Mortgage | $75,000 |
Proposed Third Lien | $25,000 |
Sum of All Current and Proposed Mortgages | $150,000 + $75,000 + $25,000 = $250,000 |
Appraised Value of Property | $400,000 |
CLTV Ratio Calculation | $250,000 (sum of mortgages) ÷ $400,000 (value of property) = 62.50% (CLTV) |
Factors That Impact the Loan-to-Value Ratio
The loan amount and value of the collateral are the two factors that impact the LTV ratio calculation. While the loan amount is something you can choose, determining the value of the collateral is a more complex process.
Lenders often reach a valuation figure with the help of certified appraisers. Depending on the type of collateral being evaluated, the methodology used by the appraiser can vary.
Real Estate Loans
If you’re getting a loan for a real estate property, appraisers generally look at the condition of the property and similar properties that have recently sold.
Below are additional items that the appraiser may consider in reaching an opinion of value:
- Average days on market for similar properties
- Sales price of recently sold properties
- Comparison of size and property features to comparables
- Seller concessions or incentives
- Condition of property
Equipment or Vehicle Loans
Similar to appraising real estate, common methods for determining the value of equipment can involve conducting research to see what similar equipment is currently being sold for. Other factors that can be considered include the following:
- Current purchase price (if buying equipment brand-new)
- Depreciation for used equipment
- Available supply for the equipment or vehicle being purchased
- Make and model
- Condition of equipment (including features, age, and mileage, if applicable)
Why Loan-to-Value Is Important
Your LTV can determine whether you are eligible for a loan and can also impact the rate you get. LTV requirements can be determined by the type of loan you’re applying for and the lender’s guidelines. In general, an LTV of 80% or lower will make you eligible for most loan programs.
From a lender’s perspective, a low LTV ratio translates to a lower level of risk. This is because defaulting on the loan can allow the lender to take possession of the asset, which it can then sell to recoup its losses. The lower the LTV, the easier it will be to cover these losses since the value of the collateral will be larger than the defaulted loan amount.
A lower LTV ratio also tends to correspond with a lower debt-to-income (DTI) ratio, comparing the amount of your monthly debt payments to your income. DTI is commonly considered a key factor in loan approvals, something we discuss in our guide on small business loan requirements.
Pros & Cons of a Low Loan-to-Value Ratio
In most cases, a lower LTV ratio is considered favorable for financing. You can consider the following pros and cons associated with getting a loan with a low LTV.
| PROS | CONS |
|---|---|
| Makes it easier to get approved for financing | Requires a larger down payment |
| Gives you a better chance of qualifying for more competitive rates and loan terms | Depletes available funds to cover unexpected expenses |
| Helps your business cash flow as it can give you lower monthly payments | Reduces funds available to invest in other areas of your company |
| Allows you to avoid expenses associated with some loans, such as private mortgage insurance | |
Pros & Cons of a High Loan-to-Value Ratio
While low LTV loans are seen as more favorable to lenders, getting a loan with a higher LTV can yield some benefits to you as a business owner.
| PROS | CONS |
|---|---|
| Preserves more cash to be used for emergencies or investment purposes | Makes it more difficult to qualify for the best advertised interest rates |
| Enables you to generate a higher return elsewhere from the proceeds not used for the down payment | Charges higher fees from approved loans |
| Reduces the time needed to save money for a loan, thanks to the smaller down payment | Causes you to become underwater on the loan due to the drops in collateral value |
How to Lower Your Loan-to-Value Ratio
Since the LTV ratio is determined by your loan amount and the value of the item being purchased, you have two options for lowering this ratio.
- Make a larger down payment: With a larger down payment, you won’t need as large of a loan, which will result in a lower LTV ratio. A larger down payment means you’ll have less working capital to use in other areas of your business, but it can lead to more affordable loan payments, a better chance of getting approved for a loan, and the ability to get more favorable rates and fees.
- Purchase something more affordable: Buying something that costs less can result in a lower LTV ratio if you use the same down payment amount. This also means you’ll have a lower loan amount, and, therefore, more affordable monthly payments.
Frequently Asked Questions (FAQs)
The LTV ratio is calculated by taking the loan amount and dividing it by the value of the collateral being pledged for the loan. Common types of collateral can include equipment, real estate, and other business assets.
An LTV of 80% and under is typically considered advantageous for improving your odds of approval and qualifying for competitive rates. However, this can vary depending on the type of loan you’re getting as well as your other business qualifications.
For mortgage loans, the LTV ratio only takes into consideration the first lienholder. It does not factor in the balances of any second mortgages or other liens against the property. An LTV ratio also does not give any insight into the strength of a borrower’s credit or finances.
Bottom Line
The LTV ratio is a key factor lenders often use to determine whether to approve you for a loan. It is typically used for loans that are secured by some type of collateral, such as real estate or equipment.
Knowing what a lender’s LTV limits are can help you choose a loan best suited for your needs, and can also help you determine your chances of getting approved. Head over to our guide on how to get a small business loan for more tips on improving your chances of landing a loan approval.
