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Understanding Loan-to-Value is Key to Real Estate Investing

Investors who want to learn how to make money in real estate are well advised to start by learning about LTV, or Loan-to-Value. This is a key concept in private real estate investing. It is one element in the calculation of the amount of financing available on a particular piece of property. Financing real estate is the primary method of achieving the highest return on investment.

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What is Loan-to-Value?

As the name implies, loan-to-value is a ratio of two values. The first value is the loan that the borrower has or wants to take out on the real estate. The second is the market value of the real estate. So if there is a loan of $60,000 on a real estate investment with a market value of $100,000, the LTV on that property is 60%.

LTV takes the total of all the outstanding loans secured by a piece of real estate into consideration. If there is more than one loan, the total of all the loans compared to the value of the property is sometimes referred to as a Combined LTV. The basic idea is the same, although the order of the loans and the LTV for each loan can have an impact on the terms of that particular financing arrangement.

Lenders look at LTV as one factor when evaluating a loan. It is used to measure the safety of the lender’s position if the borrower defaults on the loan. In this sense it is the ultimate fall back position. A lender wants to be certain that they can recover the loaned amount. Because value is an estimate and may fall due to a wide variety of factors (general economic conditions, damage to the property, etc.), lenders want some cushion in the LTV ratio to secure their position.

What is a Conforming Loan-to-Value Ratio?

Investing in real estate is very different from buying a home. Mortgages on personal residences are effectively regulated by the government through the Federal Housing Financing Agency which defines a “conforming loan”. This includes a LTV ratio that varies by the number of units in the residence. For a single family primary residence the ratio is 95%, but goes down as the number or units increase.

The conforming LTV also goes down for non-owner occupied dwellings. For investment residential properties, the maximum LTV ratio can be as low as 75% for a 4 unit property. Properties larger than 4 units are considered commercial properties and have a maximum confirming ratio of 75% to 80%.

What is a Non-Conforming Loan-to-Value Ratio?

Private lenders finance real estate transactions through the Internet. The loans they make do not conform to government guidelines. This puts the lender at a higher risk of financial loss if the borrower defaults on the loan. Intuitively, this suggests that non-conforming lenders would require a higher loan-to-value ratio, but that is not the case.

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Non-conforming loan-to-value ratios can range based on the credit score of the borrower and, most significantly, the terms of the loan. Private lenders are willing to take additional risk by lending to borrowers with poor credit and high LTV ratios in exchange for higher interest rates on the loans. This is capitalism at its most basic form. Obtaining a non-conforming loan with an LTV as high as 85% is possible, but the borrower will pay in the form of a higher interest rate.

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