Real estate investing is a definitely profitable business, but it’s not without risks. For example, when a real estate investor borrows money to purchase property, both of them are at risk.
Estimating the risks and potential rewards may be the difference between beneficial investing and ending up a bankruptcy.
LTV, LTC, and ARV are factors that determine the risk. Understanding their role in real estate investing may help you handle the real estate lending process. So let’s look closer at them.
Loan-to-Cost is a metric in commercial real estate that measures the ratio between the total loan amount and the project’s total cost. Depending on the deal, the cost is either used as construction costs or purchase price. For example, the loan to cost for a $10,000 construction project with $7,000 in financing is 70% ($7,000 divided by $10,000). Similarly, a borrower purchasing a new home for $3,000,000 with only 10% ($30,000) down will have an LTC of 90%.
Loan-to-Value: LTV is a metric in commercial real estate that measures the ratio between the total loan amount and the project’s fair market value. For example, an LTV of a building worth $200,000 and a loan of $150,000 has an LTV of 75% (150,000 divided by 200,000).
Lenders use both to measure risk – the higher the percentage, the higher the risk to the lender. So, for example, a property that is purchased at 60% LTV is safer than 80% because the borrower has injected more cash into the deal – indicating better financial strength.
After-Repair-Value of the property is a metric in commercial real estate that measures what the house should be worth after necessary repairs and renovations. Determining ARV requires examining the sale prices of similar properties that are sold in the same neighborhood over the last half-year.
The property’s AVR helps investors set limits on what they can spend on a property with minimum risks. The idea is to lighten risk while ensuring the project is profitable.
Usually, Real estate investors called flippers to follow the 70% rule. This simple formula calculates the property’s loan-to-cost ratio (LTC).
Knowing the LTC helps determine the maximum price the investor can pay for a property. But, again, the goal is to mitigate risk and make sure the project will be profitable.
This works like this: the investor pays no more than 70% of the ARV minus the cost of the renovations. So, the formula is (AVR x 0.70) – the cost of renovations = maximum purchase price.
Let’s see that in an example:
If a property’s ARV is $200,000, and the predictable cost of renovations is $40,000, the most the real estate investor will pay is $100,000.
(200,000 x 0.70) – 40,000 = 100,000
Lenders also use the 70% rule to determine the maximum loan amount and the down payment that they require from the investor. It’s advantageous for hard money loans or bridge loans because any loan is based on the asset’s value and not just your creditworthiness.
Well, let’s imagine that John has a rehab property under contract for 60,000. He has to invest 20,000 into this property for repairs, bringing his total loan amount to 80,000. His ARV appraisal says that after his work is finished, its value will be worth 100,000. However, John’s lender only lends 70% ARV and 90% LTC. As the property is under contract for 60,000, the lender will only give 90% of that amount which is 54,000.
Due to this, the lender agrees to loan 100% of the repairs (which will be held in escrow) up to the after repair value of 70%, which is 70,000. Thereafter the contract is for 60,000 and the loan amount on the contract will be 54,000, there are 16,000 left to use towards repairs, meeting the 70% ARV or 70,000. Remember that John needs 80,000 total, and that is what the appraisal was based on. Therefore, John must get the difference, which is 10,000.
Let’s look at another example. Imagine that Kate has a rental property she wants to refinance. The appraisal is estimated at 80,000. So, Kate still owes 30,000 on her lien, leaving her with 50,000 in equity. Her lender agrees to loan 70% of the LTV and 100% of the LTC. Subsequently, she would get a loan for 56,000. A major sum of 30,000 would pay off her prior lien, leaving her with 26,000 to cash out. In this scenario, Kate only pays her closing costs. Please note that lenders will allow you to roll in closing cost fees in some cases.
LBC Capital is a top Californian private money lender where you can get a hard money loan fast, securely, and without any stress. To apply for a loan, just submit the form on our website, and we will call you to approve the loan!
Our main benefit is having our own fund, so you don’t have to wait for a long time till your loan is approved (it takes only up to 24 h). Another great benefit is if you need an enormous loan amount, we are ready to give it to you. We offer loans from $ 50,000 up to $ 25 million. With over 15 years of experience and more than 7500+ closed deals, we can guarantee the reliability and security of the deal.
If you are looking for a private lender, we are available in California, Washington, DC., Florida, Texas, and North Carolina. In addition, Nevada and Arizona are coming soon.
Check our recent article on what documents you need to get a hard money loan.
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