What is Loan-to-Cost
The Loan-to-Cost (LTC) ratio is a metric that helps lenders understand the amount of risk they will be taking on when lending to a borrower by comparing the loan amount to the cost of the project.
How do lenders calculate the LTC?
LTV = Loan Amount + Construction Cost
- Loan-to-cost (LTC) ratio ensures that the loan amount is based on the project’s estimated cost which allows for a more accurate financing strategy
- Rather than the loan being based on an appraised value it’s based on the actual cost of the project
- The actual total cost of renovation or construction may be hard to predict
- Doesn’t take into consideration other liabilities, obligations and loans owed by the borrower.
What does the LOC ratio tell lenders?
The LOC ratio allows investors to provide a more accurate loan amount to the borrowing team as the loan amount with be based upon the construction costs of the real estate renovation or development project. The LOC ratio shows investors how much risk they are taking on in the deal. The higher the LOC ratio, the higher the risk and interest rate. Most lenders will maximize their risk exposure at 80% loan-to-cost. Some lenders will make an exception and provide more than 80% of the construction costs in return for a significantly higher interest rate.
What else do lenders look at when sizing a loan based on a LOC ratio?
- Experience with similar projects
- Market research
- Potential property value
- Credit report
Loan to Cost VS Loan to Value
Loan to Cost
- Loan amount is based on construction cost
- Tailored for construction projects
- Higher Interest Rate
- Higher Risk
- Loan amount provided is the amount needed to complete the construction project
Loan to Value
- Loan amount is based on appraised value
- Tailored for stabilized property acquisitions
- Lower Interest Rate
- Lower Risk
- Loan amount provided is the amount needed acquire the stabilized properties
Loan-to-Cost Calculation Example
A real estate investment group is looking for a loan for their real estate project that entails hard costs of $1.2 million and are requesting at least 75% of the cost in financing. The lender would then go through the hard costs budget and ensure that the hard costs are all project related and that they total up to $1.2 million. If the lender agrees to offer the lender a 75% loan-to-cost ratio then the loan amount would be $900K ($1.2 million * 75%).