Loan-To-Value: A Simple Equation with Complicated Implications

Loan-to-Value (LTV) is a private lender’s most important metric when deciding if a loan is safe or not. What does it mean, why is it important, and what is Enact Partners’ philosophy?


What Does LTV mean?
Loan-to-Value is calculated by taking the loan amount divided by the collateral value. The result is a percentage that is always below 100%, and tells you how much leverage is in the deal.

For example, Enact Partners funded a $750,000 loan to finance the purchase of a farm that appraised for $1,500,000. Using our simple Loan-to-Value formula, that’s $750,000 / $1,500,000 for an LTV of 50%. This means Enact Partners injected 50% of the purchase price, and the borrower put up the remaining 50% in cash.

Why Is LTV Important?
Private lenders are sometimes referred to as “hard money” lenders because we rely on the “hard” real estate assets for our collateral. If the borrower stops making loan payments, we would foreclose the real estate, sell it, and use the proceeds to recoup our loan funds, accrued interest, and fees. If the loan is too high in relation to the property value, there is risk that the foreclosure sale will not yield enough cash to cover what is due, especially if the foreclosure occurs in a down market.

What Is Enact Partners’ Risk Assessment Philosophy?
Enact Partners uses the Great Recession’s precipitous reduction in real estate values as the low watermark, a guide to how far values can drop in a down market. We try to limit the borrower’s leverage as much as possible, preferably below 50% on land, 65% on construction loans, and 70% on completed buildings.

Such a conservative approach requires a lot of patience. We have to pass on a lot of loan opportunities and sometimes get beat out by lenders offering LTV’s as high as 75-95%.

When we are feeling impatient, it’s great to remember something the “father of value investing,” Benjamin Graham once said: “The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”

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