What is Loan-to-Cost (LTC)?
Loan-to-Cost (LTC) is a financial metric used in the real estate and construction industries to assess the level of financing provided by a lender in relation to the total cost of developing a property. It is a similar calculation to Loan-to-Value (LTV), but instead of comparing the loan amount to the property’s value, it compares it to the cost of development.
LTC Calculation and Example
The LTC ratio is expressed as a percentage and is calculated by dividing the loan amount by the total cost of the project, including land acquisition, construction costs, permit fees, professional fees, and any other expenses associated with the development.
The formula for calculating Loan-to-Cost (LTC) is:
LTC = (Loan Amount / Total Development Cost) x 100
Here’s an example: If a developer is seeking a loan of $6,000,000 to finance a project with a total development cost of 10,000,000, the LTC ratio would be:
LTC = ($6,000,000 / $10,000,000) x 100 = 60%
In this simple scenario, the lender would be providing 60% of the total project cost, and the developer would be expected to contribute the remaining 40% as equity.
Why Do Lenders Use LTC Ratios?
LTC ratios are used by lenders as a risk assessment tool, helping them evaluate exposure levels when financing a development project. A lower LTC ratio indicates that the developer has a larger equity stake in the project, which can provide a sense of security to the lender. Conversely, a higher LTC ratio suggests a higher degree of risk as the developer’s equity contribution is relatively smaller.
Lenders have specific LTC requirements based on the type of project, location, and risk appetite. These requirements vary, but lenders generally prefer lower LTC ratios, often less than 65%. Higher ratios indicate a riskier investment and result in lenders either declining the loan application or charging higher interest rates to compensate for the increased risk.
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