What is the loan to cost ratio (LTC)?
The loan to cost ratio (LTC) is a metric used in commercial real estate construction to compare the financing of a project (offered by a loan) with the cost of construction of the project. The LTC ratio allows commercial real estate lenders to determine the risk of offering a construction loan. It also allows developers to understand the amount of equity they keep during a construction project.
Similar to the LTC ratio, the loan to value ratio (LTV) also compares the amount of the construction loan, but with the fair market value of the project after completion.
The LTC formula is
TheLoan at cost=Construction costAmount of the loanTheTheThe
What does the loan / cost ratio tell you?
The LTC ratio is used to calculate the percentage of a loan or the amount that a lender is willing to provide to finance a project based on the actual cost of the construction budget. Once construction is complete, the entire project will have new value. For this reason, the LTC ratio and the LTV ratio are used side by side in commercial real estate construction.
The LTC ratio makes it possible to delimit the risk or the level of risk of financing a construction project. Ultimately, a higher SLD ratio means that it is a riskier business for lenders. Most lenders make loans that only finance a certain percentage of a project. In general, most lenders finance up to 80% of a project. Some lenders finance a higher percentage, but this usually means a significantly higher interest rate.
While the LTC ratio is a mitigating factor for lenders who are considering lending, there are other factors to consider. Lenders will also take into account the location and value of the property on which the project is built, the credibility and experience of the builders, as well as the borrowers’ credit history and loan history.
Example of using LTC
As a hypothetical example, assume that the difficult construction costs of a commercial real estate project are $ 200,000. To ensure that the borrower has equity at stake in the project, the lender makes a loan of $ 160,000. This keeps the project a little more balanced and encourages the borrower to see the project through to the end. The LTC ratio on this project would be calculated as $ 160,000 / $ 200,000 = 80%.
The difference between the loan / cost ratio and the loan / value ratio
The loan-to-value ratio is closely related to LTC, but is slightly different. The LTV ratio compares the total loan granted for a project to that value of the project after completion (rather than its construction cost). Considering the example above, assume that the future value of the project, once completed, is double the hard construction costs. If the total loan granted for the project after completion is $ 320,000, the LTV ratio for this project would also be 80%.