What Is the Loan-to-Cost (LTC) Ratio?

What Is the Loan-to-Cost (LTC) Ratio?

Let me explain the loan-to-cost (LTC) ratio directly: it's a metric in commercial real estate construction that compares the financing from a loan to the total cost of building the project.

You should know that this ratio helps lenders gauge the risk of providing a construction loan. It also shows developers how much equity they're keeping in the project.

Key Takeaways

Understand that LTC directly compares the financing amount for a commercial real estate project to its overall cost. You calculate it by dividing the loan amount by the construction cost.

In contrast, the loan-to-value (LTV) ratio looks at the loan amount against the expected market value of the finished project. A higher LTC signals more risk for lenders, and most will only go up to 80% financing.

What Is the Formula for the LTC Ratio?

To get the LTC ratio, you divide the loan amount for the construction project by the total construction cost. The formula is straightforward: Loan to Cost = Loan Amount / Construction Cost.

This is similar to the LTV ratio, which compares the loan amount to the fair market value of the completed project.

What Does the Loan-to-Cost (LTC) Ratio Tell You?

The LTC ratio lets you see the percentage of a loan that a lender is willing to provide based on the hard costs in the construction budget. Once the project is done, it gains a new value, so LTC and LTV ratios are often used together in commercial real estate.

This ratio outlines the risk level of financing a project. A higher LTC means it's riskier for lenders, who generally finance only up to 80% of a project. Some might go higher, but expect a much steeper interest rate.

Remember, LTC is just one factor. Lenders also consider the property's location and value, plus the builders' experience and the borrowers' credit history.

Example of How to Use LTC

Take this hypothetical: suppose the hard construction costs for a commercial real estate project are $200,000. The lender offers a $160,000 loan to ensure the borrower has skin in the game, keeping things balanced and motivating completion.

You calculate the LTC as $160,000 divided by $200,000, which equals 80%.

The Difference Between the Loan-to-Cost (LTC) and Loan-to-Value (LTV) Ratios

The LTV ratio is related but different: it compares the total loan for the project to its value after completion, not the construction cost.

Using the same example, if the completed project's value is $400,000 and the loan is $320,000, the LTV would be $320,000 divided by $400,000, or 80%.

How Do I Calculate the Loan-to-Cost (LTC) Ratio?

Simply divide the loan amount for the construction project by the project's cost—that gives you the LTC ratio.

How Is the LTC Ratio Used?

You use the LTC ratio to figure out the loan percentage or amount a lender will provide based on the construction budget's hard costs.

How Is the LTC Ratio Different from the LTV Ratio?

The LTC ratio compares the financing to the project's cost, while the LTV compares it to the expected market value once completed.

The Bottom Line

Mainly in commercial real estate construction, the LTC ratio compares project financing to construction costs. Higher LTC means higher risk for lenders, who usually cap financing at 80%.