What is Loan-to-Cost Ratio (LTC)?
Loan-to-cost ratio, or LTC, compares a project’s financing to the cost of construction. Along with loan-to-value ratio, or LTV, LTC is one of the most important metrics that lenders look at when deciding whether to approve a HUD multifamily construction loan, like the HUD 221(d)(4) loan.
Loan-to-Cost Ratio (LTC) and the HUD 221(d)(4) Loan Program
Loan-to-cost ratio, or LTC, compares a project’s financing to the cost of construction. For example, if it costs $750,000 to purchase land, and another $1 million to construct an apartment building, and a developer is attempting to get a loan for $1.5 million, the LTC would be:
$1.5 million/($750,000 + $1 million) = 85% LTC
In contrast, a similar metric, loan-to-value ratio (LTV), compares a project’s financing to its estimated market value. So, in the same example above, if the property were worth $3 million, the LTV would be:
($750,000 + $1 million)/$3 million = 58% LTV
Overall, LTC and LTV are some of the most important metrics that lenders use to approve HUD multifamily loans like the HUD 221(d)(4) loan.
Loan-to-Cost (LTC) Calculator
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Related Questions
What is the definition of Loan-to-Cost Ratio (LTC)?
Loan-to-Cost Ratio (LTC) is a metric that compares the amount of financing a real estate construction project has to the cost it will take to build the project. In terms of HUD multifamily loans, LTC typically only affects HUD 221(d)(4) loans and HUD 232 loans, as these types of financing involve the new construction or substantial rehabilitation of multifamily and healthcare properties.
Loan to Cost (LTC) is a ratio used in commercial mortgage financing and multifamily financing to determine the ratio of debt relative to the cost of acquiring the property. Commercial mortgage lenders use the LTC ratio as a factor to determine risk in a deal: the lower the leverage, the lower the risk while higher leverage offers higher risk. LTC can be calculated by dividing the loan amount by the cost of the loan. For example, if a borrower is buying a property for $1 million, and the property is worth $2 million, and the loan requested is $800,000, then the LTC ratio is 80%.
How is Loan-to-Cost Ratio (LTC) calculated?
Loan-to-Cost Ratio (LTC) is calculated by dividing the amount of the project loan by the total project cost. The formula for calculating an LTC ratio is:
LTC = Loan Amount ÷ Total Project Cost
To illustrate, consider a commercial property rehabilitation project that has a total cost of $4 million and a lender willing to finance $3 million. Simply divide the amount of the loan by the cost of the project, and the LTC ratio comes to 75%.
LTC = $3,000,000 ÷ 4,000,000 = 75%
For example, if a borrower is buying a property for $1 million, and the property is worth $2 million, and the loan requested is $800,000, then the LTC ratio is 80%.
What are the benefits of Loan-to-Cost Ratio (LTC)?
The Loan-to-Cost Ratio (LTC) is a metric that compares the amount of financing a real estate construction project has to the cost it will take to build the project. It is commonly used in commercial lending for value-add acquisitions such as ground-up construction or the acquisition of properties that require substantial rehabilitation. The LTC ratio is a valuable factor in the determination of the potential risk in a deal, as the lower the leverage, the lower the risk.
The benefits of using the LTC ratio include:
- It is a useful metric for understanding the borrower’s debt in relation to the cost of a project.
- It is a valuable factor in the determination of the potential risk in a deal.
- It is independent of the value of a property.
For more information, please visit What is Loan-to-Cost Ratio (LTC)? and Loan-to-Cost Ratio Calculator.
What are the risks associated with Loan-to-Cost Ratio (LTC)?
The risks associated with Loan-to-Cost Ratio (LTC) are related to the amount of leverage used in the financing. The higher the leverage, the higher the risk. Commercial mortgage lenders use the LTC ratio as a factor to determine risk in a deal. If the LTC ratio is too high, the lender may not approve the loan or may require additional collateral or a higher interest rate to offset the risk. (Source)
In terms of HUD multifamily loans, LTC can also affect the amount of equity that must be contributed by the borrower. If the LTC ratio is too high, the lender may require the borrower to contribute more equity to the project. (Source)
What types of commercial real estate loans use Loan-to-Cost Ratio (LTC)?
The Loan-to-Cost Ratio (LTC) is used in commercial real estate loans for construction or rehabilitation projects. Common types of loans that use LTC include bridge loans, construction loans, and permanent loans. Bridge loans are short-term loans used to finance a project until long-term financing can be obtained. Construction loans are used to finance the cost of building a new structure or renovating an existing one. Permanent loans are used to finance the purchase of an existing property.
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What are the alternatives to Loan-to-Cost Ratio (LTC) for financing commercial real estate?
The Loan-to-Cost Ratio (LTC) is one of the most common methods of financing commercial real estate. However, there are other alternatives available, such as:
- Cash-on-Cash Return - A measure of the cash income generated by an investment property compared to the cash invested in it.
- Debt Service Coverage Ratio (DSCR) - A measure of a borrower's ability to make their loan payments.
- Loan-to-Value Ratio (LTV) - A measure of the loan amount relative to the value of the property.