The loan-to-cost ratio (LTC ratio), 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.
The LTC ratio is reflected as a percentage. It is used by lenders to determine the risk level of a particular loan, with a lower LTC being viewed more favorably; and, 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.
Example of How to Calculate the Loan-to-Cost Ratio
Below is an example of how you can calculate the LTC ratio given a list of common project costs.
The LTC formula is:
Total Project Cost
Construction & Renovation Costs
Total Project Cost
(Loan Amount ÷ Total Project Cost) × 100
($400,000 ÷ $650,000) × 100 = 61.54%
How To Determine Total Construction & Renovation Costs
While the formula for LTC is simple, determining total construction costs can be more difficult as it may encompass a wide range of items. 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:
- Insurance costs
- Permitting fees
- Environmental studies
- Land surveys
When the Loan-to-Cost Ratio Is Used
The LTC ratio is often used when a property needs repairs, requires renovations, or has construction costs involved. This is typically seen with the following scenarios:
- 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 guide for 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.
Why the Loan-to-Cost Ratio Is Important as a Borrower
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):
- 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. Meeting a lender’s minimum requirements does not always guarantee a loan 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 LTC’s 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 Is Important 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.
LTC Comparison to Related Ratios: After-Repair Value (ARV) & Loan-to-Value (LTV)
If you’re looking for a mortgage loan, you may also 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. You can also head over to our list of other common business loan requirements to see what additional items may apply:
- ARV: The ARV is calculated by taking the sum of the property’s purchase price and the value of the completed renovations. You can learn more about how it could apply to you and how to calculate it in our article on what the ARV is.
- LTV: 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. Check out our guide on the LTV ratio to learn more about how to calculate it and its importance.
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.
Lenders typically look at LTC ratios when a property is in need of 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 loan-to-cost ratio measures your loan amount against the total cost to repair, construct, or renovate a property. The lower the LTC ratio, the more likely you are to get approved. Some lenders determine the rate you get based on your LTC, so you can opt for a lower loan amount if you want a better rate and have enough of your own funds to use.