The LTC is used in commercial mortgage financing and multifamily financing. The Loan-to-Cost Ratio can help to determine the amount of debt relative to the cost of purchasing a property, or the total cost of a project as a whole.
Lenders use the LTC ratio as a method to determine the amount they are willing to issue to a borrower which will help them complete their project or finalize the purchase of their house.
There is a universal formula that is used to calculate LTC ratios.
Loan Amount / Total Cost = LTC
Here’s a practical example:
If a borrower wants to purchase a property of $750,000, and the loan amount requested is $450,000, the LTC ratio would then be 60%.
This puts the borrower at 60% equity in the purchase of the property and also gives them the motivation to complete the repayment of the loan or mortgage.
Depending on the financial institution, lenders will typically arrange a maximum loan-to-ratio amount and maximum dollar amount.
For our example, the lender could either set an LTC of 60% or $450,000.
If there’s perhaps a chance that the buyer can make up the full amount of $450,000, while still being below 60%, they could then be required to use their personal savings or cash to complete the purchase.
The LTC is used as a way to determine the overall risk for the lender, not so much for the borrower. If a borrower has a lower LTC ratio, the leverage of risk involved is also a lot lower for the lender.
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