Loan-to-value Basic Question

3 Replies

Hi,

I am a brand new to the BiggerPockets community and trying to learn about REI so that I can begin investing on my own.

I am trying to understand how LTV works and why it is that low LTV is typically worse for the investor? Why is it that with low LTV you typically have less of the value of the asset available to you as cash?

Thanks in advance for entertaining what to many may seem like a stupid question :)

Patrick

I’m not sure I completely understand what your asking but I’ll try to answer.

Let’s say you buy a property for $100,000 with a cap rate of 10% and you get a mortgage at the rate of 6%. Let’s look at LTV of 50% and 75% and ignore property appreciation.

50% LTV
Loan = 50,000
Downpayment = 50,000
Interest = 50,000 * 6% = 3,000
Annual income = 100,000 * 10% = 10,000
Your income net of interest = 10,000 - 3,000 = 7,000
Your return = 7,000 / 50,000 = 14%

75% LTV
Loan = 75,000
Downpayment = 25,000
Interest = 75,000 * 6% = 4,500
Annual income = 100,000 * 10% = 10,000
Your income net of interest = 10,000 - 4,500 = 5,500
Your return = 5,500 / 25,000 = 22%

If mortgage rate is lower than cap rate then the higher the leverage the greater your percent return and more money you have for other properties to purchase. However, more risk you have from vacancies and deadbeats impacting your income. This simple example also ignores the principle you pay down.

I'm not sure how much of an understanding you have so, in basic terms, LTV is the percentage of the value of a property a bank will lend you. So if you have a house worth $100k, and the bank will lend you 60% LTV, the most they will give you is $60k. Low LTV loans can require you to have a lot of cash tied up in a property and, therefore, slow the process of buying more properties. On the other hand, having more equity in the property helps mitigate the risk of a housing downturn. There are pros and cons to both high and low LTV loans, you will need to decide which works best for your specific situation.