The loan-to-cost ratio, also known as LTC, is a calculation that’s used to evaluate the costs of a commercial real estate project. It is calculated by taking the loan amount of a commercial mortgage and dividing it by the property’s total project costs Project costs can include things like the purchase price, renovation costs, construction costs, and other related expenses incurred as a part of completing the improvements or repairs. . It is reflected as a percentage.
Lenders use the LTC ratio to determine the risk level when issuing financing, with a lower LTC being viewed more favorably. In most cases, an LTC of 75% or less is considered good. You can also use the LTC to determine if you’ll make a profit based on the total costs involved.
You can use our calculator below to quickly calculate the LTC for your project.
Loan-to-Cost (LTC) Ratio Formula
The LTC formula is:
LTC = | Loan Amount | × 100 |
Total Project Cost |
Example of How to Calculate the Loan-to-Cost (LTC) Ratio
Below is an example of how you can calculate the LTC ratio given a list of common project costs.
Project Costs | |
Purchase Price | $500,000 |
Construction & Renovation Costs | $150,000 |
Total Project Cost | $650,000 |
Loan Details | |
Loan Amount | $400,000 |
LTC Calculation | |
(Loan Amount ÷ Total Project Cost) × 100 | ($400,000 ÷ $650,000) × 100 = 61.54% |
How to Determine Total Construction & Renovation Costs
Although the LTC calculation is simple, determining what project costs should be included can be more difficult due to the wide range of items to consider. These items can also vary from one project to the next. Below, we’ve summarized some common expenses that are considered part of construction and renovation costs for purposes of the LTC ratio:
- Materials
- Insurance costs
- Labor
- Permitting fees
- Environmental studies
- Land surveys
When the Loan-to-Cost Ratio Is Used
The LTC ratio is generally used when a borrower is seeking a loan to finance the repair, renovations, or construction costs of a real estate project. The LTC calculation is utilized by lenders to compare these costs and determine how much risk is involved with the project. It’s commonly used for the following:
- Fix-and-flip investors: Borrowers looking to purchase a property, conduct repairs, and then resell the home for a profit are considered fix-and-flip investors. The initial loan is typically short-term (less than 36 months) and is designed to be paid off once repairs are complete and the property is eligible for permanent financing. See our recommendations for the best fix and flip loans.
- Fix-and-hold investors: This type of investor is similar to a fix-and-flip, but the key difference is that after repairs to property have been completed, the investor will retain ownership of the home and use it as a source of rental income. The initial loan obtained is also short-term and is usually replaced with permanent financing once the repairs and renovations are done.
- New construction borrowers: This might apply in the event of a new build or teardown of an existing building where ground-up construction would need to be involved. Here, the loan amount would be compared with the construction costs to determine the LTC ratio.
What Makes a Good Loan-to-Cost Ratio
In general, the lower the LTC ratio, the better your chances of getting approved for financing. A higher LTC represents that there is a higher risk in issuing financing, and lenders likely won’t take a chance on the deal.
That said, a good LTC ratio generally is 75% or lower. Keep in mind, this may vary depending on the lender you work with, the type of loan you’re seeking, and your business qualifications.
Why the Loan-to-Cost Ratio Is Important
The LTC ratio is a useful calculation that can benefit both a borrower and a lender. Below, we touch upon the importance of this ratio for both parties, whether it be to evaluate risk or determine loan terms.
Why the Loan-to-Cost Ratio Matters to Borrowers
As a borrower, knowing what your LTC ratio is can help you improve your odds of getting a loan. It can also be used to manage the amount of risk on a project to help you get a sufficient return on investment (ROI). Here are some of the uses applicable to borrowers calculating their LTC:
- You can determine your maximum loan amount: A lender’s maximum LTC will be one factor that determines how much you can borrow. Take a lender’s LTC and multiply it by the total project costs to get the maximum amount you may borrow. For example, with total project costs of $300,000 and a lender’s maximum LTC of 80%, you can get a loan no greater than $240,000.
- It can improve your approval odds: Knowing what a lender’s maximum LTC is can help you improve your chances of getting approved for financing. Meeting a lender’s minimum requirements does not always guarantee approval, and if you want to get the highest LTC possible, you may need compensating factors such as strong business credit or finances. For more details on this, see our guide on how to get a small business loan.
- You can get more favorable loan terms: In addition to boosting your odds of a loan approval, you can get lower interest rates and longer repayment terms if you know what your LTC is. Lenders view lower LTCs as less risky, and can therefore issue more favorable loan terms.
- You can determine your ROI: As part of calculating your LTC, you can check the total project costs against your previous estimates. Doing so can help you catch overlooked expenses that may otherwise reduce your expected profit and ROI.
Why the Loan-to-Cost Ratio Matters to Lenders
High LTC ratios represent a greater risk for a lender because it makes it less likely it will be able to recoup its financial losses in the event of a default.
If a borrower defaults on a mortgage, the lender typically has the right to take possession of the property. It can then sell the property and take the sales proceeds to offset the losses it incurred on the defaulted mortgage loan.
However, this process can be time-consuming, and the lender may also incur additional costs involved with repossessing and selling the property. As a result, the higher the LTC, the greater the likelihood that the lender will be unable to cover its losses.
How to Improve Loan-to-Cost Ratio
Lenders will have their own standards for qualifying LTC ratios. While LTC is dependent on project costs and financing amount, there are other factors that can influence a lending decision for borrowers with a high LTC ratio. For businesses looking to increase their odds of approval, it can be done in several ways. Some items to consider are:
- Making steps to improve your credit score
- Demonstrating strong financial history of your business
- Providing detailed information regarding your investment project
- Comparing rates and terms
- Making a larger down payment
LTC Comparison to Related Ratios: After-repair Value (ARV) & Loan-to-Value (LTV)
For mortgage loans, there are often other calculations that are taken into consideration when seeking financing. You may come across other terms such as after repair value (ARV) and loan-to-value ratio (LTV). Whether these ratios apply to you will depend on the lender you choose and the intended use of the loan proceeds.
- The ARV is calculated by taking the sum of the property’s purchase price and the value of the completed renovations.
- The LTV ratio measures your loan amount against the current value of the property it’s secured by. Just like the LTC ratio, LTV is often used by lenders for purposes of determining what rates and terms to offer.
You can also head over to our list of other small business loan requirements to see what additional items may apply.
Frequently Asked Questions (FAQs)
A good LTC is typically 75% or below. Lower LTC ratios can help with improving your chances of getting approved and getting better loan terms and lower interest rates. LTC ratios can vary depending on the lender you choose, the type of loan you’re looking for, and the strength of your business credit and finances.
LTC is used to compare the cost of a commercial real estate project compared to the loan amount needed to finance it. Lenders typically look at LTC ratios when a property needs repairs, renovation, or construction. Common loan types include fix-and-flip, fix-and-hold, and construction loans. Total project costs typically include the purchase price and any hard and soft expenses associated with the project. Some examples can include materials, labor, insurance costs, county permitting fees, and inspection costs.
The difference between them is that LTV evaluates the financing amount compared to the market value of the project, whereas LTC measures the financing amount versus the cost of the project. Both ratios are used to determine the risk involved with financing a project.
Bottom Line
The LTC ratio can help to determine the level of risk involved with financing a real estate project, as it evaluates the cost of the project in comparison to the amount of financing needed. Whether it be to repair, construct, or renovate a property, this calculation is useful to both lenders and borrowers to determine loan terms. Generally, the lower the LTC ratio, the better your odds of approval.
