When you borrow money to buy an asset, like real estate or equipment, the lender is going to look at your target loan-to-value (LTV) ratio. The Consumer Financial Protection Bureau defines the LTV ratio as the amount you want to borrow divided by the value of the asset.
For example, let’s say you want to buy a $100,000 piece of equipment and hope to borrow $80,000. Your ratio is 0.8 or 80% ($80,000/$100,000 = 0.8).
Why the Loan-to-Value Ratio Matters
If you’ve taken out a home loan, you’re probably familiar with the LTV ratio, but it’s also an important figure for business owners to know, especially if you want to buy commercial real estate with a mortgage, or take out an equipment loan.
Traditional lenders can have tougher standards for business loans than they would for personal loans. They might require a larger down payment and set a limit on their maximum ratio, like 70% to 80% of the asset. This is one of the obstacles to getting a small business loan.
How to Plan Your LTV Ratio
Reducing your target ratio on a loan could better your chances of qualifying — and at a lower interest rate. By making a larger down payment, you’re lowering the risk for a traditional lender, so they might be more willing to give you better terms.
But even if you can’t make a large down payment, you have options. There are alternative lenders willing to give higher LTV ratio loans; they may even let you borrow loans for equipment financing without a down payment. This way, even if you’re in a cash flow crunch, you can still buy the tools your business needs to get the job done.