The loan to value ratio or LTV is a measurement of the risk level for the lender based on the amount of money being borrowed compared to the asset being purchased. It is most often used for assets that serve as loan collateral.
When the risk is lower, the lender may be open to offering better terms on the loan as the loan has a better chance of being paid back. Better loan terms can include:
- Lower interest rates
- Smaller required down payments
- Less collateral being required
- A limited personal guarantee vs. an unlimited personal guarantee
- Waived origination fees
A less risky loan is different from a borrower being “creditworthy” even though they both help the borrower get an approval. Both lower LTVs and creditworthiness reduce a lender’s risk, but the LTV ratio is about the risk with the amount of the small business loan compared to the asset, and creditworthiness is about the borrower’s financial standing and ability to make payments.
LTVs are easy to calculate with a simple formula, while the creditworthiness of the borrower is a measurement of tangible and intangible assets like reputation and trustworthiness.
How to Calculate the LTV for a Loan
A loan to value ratio is calculated by dividing the loan amount by the asset value and multiplying the number by 100.
Loan Amount / Asset Value x 100 = LTV
If you take a business loan for $50,000 to purchase an asset worth $100,000, the formula will look like this:
$50,000/$100,000 x 100 = 50% LTV
Your goal as a borrower is to lower this number as much as possible before applying for a loan so that the LTV percentage is lower. By lowering the number, you decrease your risk as a borrower and may have a better chance of getting approved.
How to Lower Your LTV Ratio
The easiest ways to lower your loan to value ratio are:
- Putting a larger deposit down
- Asking for less money
- Paying all fees and costs upfront rather than adding them to the monthly payments
The first and easiest way to lower your LTV is by making a larger deposit on the loan. This reduces the amount borrowed and decreases the ratio. $5,000 in the example above can have a big enough impact:
$45,000/$100,000 x 100 = 45% LTV
Look for any expenses including travel and trade shows in the near future that can be cancelled. The savings can be used to increase the deposit amount, which lowers your loan to value ratio. The next easiest way is if you can finance more of the purchase yourself and ask for less money.
If you have investments like stocks and bonds, you can sell them and put the money toward the buying price. This lowers the amount of money being borrowed, decreasing the amount you divide by the asset’s value and decreasing the loan to value ratio.
When the asset is a vehicle or equipment, see if there is one that is appraised at a higher value but costs roughly the same. The higher value divided by the same amount borrowed lowers the LTV ratio. If the asset is property, a property assessment for taxes will occur, and you can wait until the new valuation comes in. This could increase the value even if the buying price is the same.
One final way to lower your LTV ratio is to pay all fees and costs up front, like the origination fee that covers administrative costs, instead of having the costs included in monthly payments. If the origination fee is rolled into the amount borrowed, your LTV ratio increases along with your risk levels.
Loan to value ratios are used by lenders to determine the risk of a loan based on the asset being purchased. They apply to equipment financing, inventory loans, and real estate. Think of ways that you can lower the LTV when you’re applying for a loan, and you may increase your chances of getting approved.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
