What is the 'Loan-To-Cost Ratio - LTC'
The loan-to-cost (LTC) ratio is a metric used in commercial real estate construction used to compare the financing of a project as offered by a loan to the cost of building the project. The LTC ratio allows commercial real estate lenders to determine the risk of offering a construction loan. Similar to the LTC ratio, the loan-to-value (LTV) ratio compares the construction loan amount to the fair-market value of the project.
BREAKING DOWN 'Loan-To-Cost Ratio - LTC'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 hard cost of the construction budget. After the construction has been completed, the entire project will have a new value. For this reason, the LTC ratio and the LTV ratio are used side by side in commercial real estate construction.
Assume that the hard construction cost of a commercial real estate project is $200,000. To ensure that the borrower has some equity at stake in the project, the lender provides a $160,000 loan. This keeps the project slightly more balanced and encourages the borrower to see the project through. The LTC ratio on this project is 80%.
The LTV ratio compares the total loan given for a project against the value of the project after completion. Considering the above example, assume that the future value of the project, once completed, is double the hard construction costs. If the total loan given for the project, after completion, is $320,000, the LTV ratio for this project is also 80%.
Significance to Lenders
The LTC ratio helps to delineate the risk or risk level of providing financing for a construction project. Ultimately, a higher LTC ratio means that it is a riskier venture for lenders. Most lenders provide loans that finance only a certain percentage of a project. In general, most lenders finance up to 80% of a project. Some lenders finance a greater percentage, but this typically involves a significantly higher interest rate.
While the LTC ratio – as well as the LTV ratio – are both mitigating factors for lenders that are considering the provision of a loan, they must also consider other factors. Lenders take into account the location and value of the property on which the project is being built, the credibility and experience of builders, and the borrowers' credit record and loan history as well.