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If you’re looking to purchase equipment, vehicles, or property for your business, lenders will surely look at your loan to value ratio. The loan-to-value ratio is a figure that lenders use to calculate whether or not you qualify for a loan. Since it’s a critical part of the business lending process, it’s important to learn about LTV and what a good loan to value ratio is. You can also use a loan to value ratio calculator to help you reach your exact figure. Doing this can help you know where you’re at and improve your chances of obtaining financing.
What is a Loan to Value Ratio (LTV)?
The loan to value ratio (LTV) compares the amount of the loan you intend to borrow to the appraised value of the thing you desire to purchase. This ratio commonly applies to equipment, automobiles, and commercial real estate. It’s extremely important when it comes to business funding, as it heavily influences loan approval.
In short, a loan-to-value ratio identifies how much of the asset you will own versus how much you’ll owe. The higher the LTV, the higher the risk for the lender. This is because if the borrower defaults or fails to pay back a loan, the lender is less likely to get their money back by selling the asset. This is true of anything you choose to purchase with the funds, whether it’s real estate, equipment, or business expansion. Lenders are significantly more likely to approve loans for businesses with lower risks and LTV’s. Because of this, it’s important to know what lenders consider a good loan-to-value ratio.
What is a good loan to value ratio?
A good loan to value ratio varies by industry. For example, in commercial real estate, a good loan to value ratio is normally 80% or less. What a good loan to value ratio is can vary from institution to institution, of course. But in general, this figure is widely accepted in the financial industry. The average loan to value ratio varies by state, which could affect what your lender will accept. Make sure to do your research after you calculate your ratio and compare it to the average in your state.
How Lenders Use Your Loan to Value Ratio
While it’s important to the process, lenders look at more than just the LTV when deciding whether to approve applicants. Providers look at a variety of other factors, such as:
- Credit Score: The lower the credit score, the higher the interest rate terms. If you have a low business credit score, lenders will consider you to be at a higher risk of default.
- The condition of the asset: If the asset you’re looking to buy is in poor shape, it will need additional funding to bring it to a higher level of value. In general, the better the quality and condition an asset is in, the less the risk.
- Debt to income ratio: Purchasing an asset is one thing, while the total amount of outstanding debt a borrower has is another. Even if the loan is small, a high debt-to-income ratio could cause a lender to deny your application. Keep in mind that with business loans, lenders may also look into your revolving utilization.
Knowing what counts as a good loan to value ratio is only the first step. Once you calculate what your ratio is, the financial institution will review it and other factors. This will help them gain a better picture of your level of risk.
Calculating Your LTV
Calculating your loan to value ratio is not complex. In fact, you can do it in just a few minutes.
First, you will need to know some specific numbers for your business. First, the loan amount you wish to be approved for. And second, the appraised value of the asset. Once you have those numbers handy, go ahead and input them into the following formula:
Loan amount / Appraised value = LTV
For example, say you wish to obtain a $200,000 loan to purchase an office space that has an appraised value of $250,000. You will be using $50,000 of your own savings to use as a downpayment.
The formula and inputs would look like this:
$200,000/$250,0000= .8
.8 x 100= 80%
According to the formula, your LTV score is within the limits of acceptability.
In situations that are a bit more complex (like those with multiple mortgages or liens), you can use a loan to value ratio calculator online to help you find the LTV.
How to Lower your LTV
If you discover after using the formula or a loan to value ratio calculator that your LTV is higher than 80%, there are options. Likewise, these options can also help you if you wish to reduce your existing LTV ratio.
It is important to note that LTVs higher than 80% for a property loan will require the borrower to also purchase Personal Mortgage Insurance (PMI) to protect the lender. Once the loan-to-value ratio goes down, you can cancel the PMI.
If you desire to lower your LTV, here are a couple proven ways to accomplish this goal:
- Make a bigger down payment: While the excitement of new equipment or office space is motivating, lenders will use the down payment amount as an indicator of risk. The more a borrower invests out of their own money, the more serious they tend to be with their investments.
- Look at less expensive options: The loan to value ratio calculator will show just how impactful the asset value is to the LTV. If the asset you wish to acquire costs less, then you will need a smaller loan. This, in turn, leads to a lower LTV.
Factors That Limit Your Loan to Value Ratio
While a low LTV can seem like a magical number at first, lenders take other things into considerations before approving your application.
One limitation to the potency of the LTV is that it doesn’t factor in a borrower’s second mortgages or other debt obligations. More often, lenders will use the Combined Loan to Value (CLTV) to get the full picture of their potential borrowers’ level of risk.
Final Thoughts
Now that you know what a loan to value ratio is and how to calculate it, it’s time to look at your options. You may decide to wait and improve your score before applying for a loan. Or, you may have an excellent CLTV and need clarity on how you will appear to a lender. The best way to find out where you stand is to speak to multiple lenders to find out what terms they can offer you.
