There are two really important numbers you should keep your eye on in looking for fix and flip lending: LTV and ARV. These are Loan-to-Value and After-Repair-Value. In this article, let’s look at what LTV is and why it’s so important.
Loan-to-Value (LTV) is a tool real estate investors use to gauge and manage risk in their investments. Whether you’re a buyer or a lender, LTV can help you protect your investment property.
What does Loan-to-Value mean?
LTV is a simple ratio used to show the loan amount compared to the value of the property.
LTV is one of the methods used by conventional and private lenders to determine the loan’s perceived risk and one of the greatest indicators of its future success. A lower LTV indicates that you, as the borrower, have put protective equity into the property to secure the loan. When you hear the terms “upside down” or “short sale,” that indicates that the property is worth less than the amount owed on it.
Consider you are looking at an investment property valued at $100,000. A lender that requires an 80 percent LTV would loan you $80,000 on that property.
$80,000 / $100,000 = 80%
This number also answers the question of how much you will have to bring to the table. You will be required to contribute the other 20 percent as a down payment to secure the loan.
Lenders care a great deal about LTV and may charge a higher interest rate for LTVs above their threshold. An LTV below 80% provides the lender with some security, should they need to repossess the property.
A Little History on LTV
Many homeowners and investors who obtained loans in the early 2000s with high LTVs found themselves upside down during the housing crisis. They had no equity left in their property and owed more than the property was worth.
The Great Recession starting in 2007 is a great example of how LTV can protect an investment property. Let’s assume you purchased a home in 2008 in Florida for $200,000. You put a down payment of 30% and financed the remaining $140,000. At the time your loan was created, your LTV was a respectable 70%.
By 2012, the housing market in the entire state of Florida had dropped by an average of 40% from 2008. Since your loan was created with only 70% LTV, you had protective equity in the property securing a large portion of your investment.
Luckily, since then, home flipping is at a 10-year high with improving returns and rates for investors.
Why do investors care about LTV?
Your rehab lender is looking for indicators that your project will be successful. When a buyer puts 20% or more down on a property, they are less likely to default on the loan. By putting a large cash down payment, the buyer has more invested in the property up-front and has more to lose. A buyer who puts a 5% down payment may find it easier to walk away from the property since their up-front investment is relatively small.
So are rehab lenders only looking out for themselves when they set LTV requirements?
Definitely not. Actually, in some cases, you can get 100 percent of the purchase price funded and borrow 100% of your rehab and construction costs - but only with the best private money lenders. However, with these loans, you will probably end up paying a much higher interest rate because your lender is taking on more of the risk with your investment.
If you have a lower LTV, you will most likely be offered a lower interest rate as a gesture of goodwill from your lender since you are contributing a higher percentage of the property value from the start and sharing the risk.
If you have questions about financing your next rehab project, let us know. We’re proud to offer rehab loans where you put down as little as 10% of the purchase price and borrow 100% of your rehab and construction costs with a schedule for funds disbursed at closing and for future construction draws. You can also see how our clients have used our rehab loans below.