Much of what makes hard money unique is also that which makes this type of lending so different from traditional bank lending. On the other hand, we hard money lenders do have a few things in common with banks and credit unions. Among them is the use of the loan-to-value (LTV) ratio in determining how much we are willing to lend on a given deal.
You may already be familiar with LTV if you have previously purchased property. The LTV concept is pretty universal on all sorts of property deals. We use it the same way as banks and credit unions use it, primarily as a tool for establishing how much we are willing to lend in relation to the value of the property in question.
The thing that makes LTV different in hard money is that it applies to the collateral a client is offering. Since most of the loans we make are destined for commercial and investment properties, the properties being obtained frequently act as the collateral. But that is not always the case. We sometimes have clients that offer separate collateral.
How LTV Works
In practical terms, it is rare to find a lender willing to offer 100%. Hard money lenders don’t go that high for the simple fact that we expect borrowers to put some skin in the game. As such, we generally lend a certain percentage of what the client is looking for. We base that percentage on collateral.
For example, we recently funded a project here in Utah for which the borrower offered fifteen acres of land as collateral. We went through our normal valuation process to determine what that land was worth. When all was said and done, we offered the borrower a 58% LTV, which is to say we loaned an amount equal to 58% of our value determination.
Incidentally, the LTV we offered on this loan isn’t hard and fast. We look at each loan on a case-by-case basis. Some deals are worthy of a higher LTV while others need a lower LTV to make them doable. This particular deal worked out at the LTV we offered. The client was happy and so were we.
LTV Protects Everyone Involved
When you are looking to borrow money, the LTV ratio can seem like a negative thing. It can seem like an artificial limit that prevents you from getting the full amount you need. But truth be told, LTV is an important tool. It protects everyone involved against getting in too deep.
For our part, we utilize LTV to minimize our risk. We would love to be able to help every client who approaches us with a proposal. But some proposals are simply too risky. LTV helps us manage risk by ensuring that we don’t lend more than would be reasonably safe.
LTV also protects clients by preventing them from borrowing too much. If we learned anything from the 2008 real estate crash, it is that too many people borrowing too much money creates a precarious position. The financial sector really doesn’t want to repeat that again. LTV is one of the tools we utilize to that end.
Collateral Is King in Hard Money
The ultimate lesson to learn here is that collateral is king in the hard money game. Clients offer collateral in their proposals. We value that collateral and then lend a certain percentage of its value. That is how LTV works. On the loan we recently made to the client who offered fifteen acres, the LTV was somewhat lower. But in the end, everyone was satisfied, and the loan was made.
