What Is a Loan-to-Value Ratio?

The loan-to-value ratio, more commonly known as LTV, is an important metric in commercial real estate financing that compares financing to the value of the collateral. The loan-to-value ratio is one of the most important metrics to commercial mortgage lenders, which use it to gauge the level of risk and borrower leverage of any potential deal.

LTV Calculator

How to Calculate the Loan-to-Value Ratio

The formula for calculating the loan-to-value ratio is:

LTV = Loan Amount ÷ Total Value of Collateral

So, for example, if the owner of an office asset worth $10 million seeks to refinance the first mortgage on the property for $8 million, the transaction would have an LTV of 80%, as seen below.

LTV = 8,000,000 ÷ 10,000,000 = 80%

Usage and Application of the Loan-to-Value Ratio

Lenders often look at the LTV of a transaction to determine both the leverage a borrower has and the level of risk in the deal. Generally speaking, the lower the LTV, the lower the risk for the lender. LTV is primarily used as a risk mitigation metric in standard asset purchase and refinance transactions.

For ground-up developments or rehabilitation projects, lenders generally prefer the loan-to-cost, or LTC, ratio instead. This calculation swaps out the collateral’s value for the total development cost. If using an LTV ratio for such a project or any type of value-add opportunity, lenders typically use the value of the finished or stabilized property.

While LTV ratios are a critical component in determining loan amounts and risk, they are taken into consideration along with other key metrics such as the debt service coverage ratio, LTC, and sometimes even the debt yield. These metrics, in conjunction with factors such as the property type, asset class, location, and market, all play a role in how a lender underwrites a commercial mortgage and the amount of financing a borrower is eligible for.