What Does Loan-to-Cost Mean?
Loan-to-cost (LTC) is a real estate construction term that compares the amount of financing needed to fund a project against the total cost of completing it. This will result in a percentage that the lender will use to calculate the viability and interest rate of a loan.
Understanding the Finer Points of the Loan-to-Cost Ratio
- What does loan-to-cost mean in practice?
- What about loan-to-value?
- Other metrics that lenders take into consideration
What does loan-to-cost mean in practice?
Calculating loan-to-cost is simply a matter of dividing the loan amount by the total cost of construction. For example:
The loan amount is $1 million.
The projected costs for the entire project—including the purchase of land, materials, labor, permits, and everything else. In this example, it’s been calculated at $650,000.
We divide $1,000,000 by $650,000, with the resulting figure expressed as a percentage. In this case, it’s 65%.
This figure gives the lender valuable information. The higher the percentage, the higher the risk of the loan. You’ll often hear this termed as “leverage”.
In practice, while getting finance for more than 80% is possible, this will almost definitely come with a premium interest rate. Most lenders like to ensure that the borrower also has some bandwidth (AKA equity in the project), thus the 80% mark tends to be the upper leverage marker in most cases.
What about loan-to-value?
We can’t talk about loan-to-cost without mentioning loan-to-value (LTV). This is because most lenders take both into account when assessing a loan.
The loan-to-value ratio considers the cost of the loan against the value of the finished project. If, for example, the final value is expected to be $1,600,000 against the original $1,000.000 loan, then the LTV would be $600,000—or 62.5%.
Both loan-to-cost and loan-to-value metrics are important. They provide the borrower and lender with figures to determine the viability and risk level of a project. For both calculations, the higher the value is, the more significant the risk.
Other metrics that lenders take into consideration
Financiers are likely to take other aspects on board when deciding whether or not to lend money. While the most important metric in a construction-heavy project is loan-to-cost (followed by loan-to-value) the following may also be contributing factors:
- The location of the project
- Credit records
- Previous loan histories
- The credibility, reputation, and track history of involved professionals and artisans (project managers, builders, other investors, etc.)
The more favorable this information is, the more attractive it will be for the lender to provide finance.
To sum up, while loan-to-cost and loan-to-value are both usually taken into consideration, LTC is the primary calculation used for real estate construction projects,
The difference between LTC and LTV is important to understand. It can be summarized as:
- Loan-to-cost: Considers the total cost of the construction work against the amount of the loan.
- Loan-to-value: Takes into account the value of the completed project and calculates this against the total value of the loan.
In both cases, amounts greater than 80% are unlikely to be approved—although some lenders will do so. Because this represents a greater risk, the interest rates are likely to be significantly higher.
Get the Lowdown on What Does Loan-to-Cost Mean and Other Lending FAQs at BRRRR Loans
As one of the country’s leading real estate lenders, BRRRR Loans is ideally placed to help you navigate the maze of property and construction funding. Whether you want to try your first fix & flip or you need to finance a huge commercial construction project, we offer some of the lowest interest rates and fastest closing times in the business.
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