The loan-to-value (LTV) ratio measures the amount of debt used to acquire an asset. The LTV is measured when the asset is initially purchased, and the LTV is measured regularly as the principal loan balance is repaid and the FMV of the asset fluctuates.
The LTV ratio is important from a lender’s perspective because certain loan types are only available within certain LTV ratio ranges.
The formula to calculate the initial LTV is as follows:
LTV Ratio = Loan Amount / Asset Purchase Price
The formula to calculate subsequent LTV is as follows:
LTV Ratio = Outstanding Loan Balance on Given Date / Market Value of the Asset on the Same Date
Example LTV Calculation on Purchase Date
Company A wants to purchase a commercial building to use as its head office. The building is listed for $2,000,000, and the Company is approved for a loan of up to $2,000,000. However, the bank is not going to loan the Company the full $2,000,000 because the bank does not extend commercial real estate loans if the LTV exceeds 70%.
On July 1, 2020, Company A purchased the building for $2,000,000 using $650,000 of its own cash and then borrowed $1,350,000 from the bank.
LTV Ratio = $1,350,000 / $2,000,000
LTV Ratio = 0.675 or 67.50%
The LTV ratio on the purchase date is 67.50%. The bank is comfortable with the loan amount because the LTV is below 70%.
Example LTV Calculation at a Later Date
Using the same fact pattern above, assume that the bank wants to check the LTV on October 1, 2023, which is over three years from the initial purchase date. As of October 1, 2023, the outstanding principal balance on the loan is $1,170,000, and the fair market value of the property is now $2,100,000.
The LTV ratio on October 1, 2023, is calculated as follows:
LTV Ratio = $1,170,000 / $2,100,000
LTV Ratio = 0.557 or 55.71%
The LTV ratio on October 1, 2023 is 55.71%.