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Is LTV the best criteria? Print

Is Loan to Value (LTV), the best criteria to use when investing in private money / hard money loans?
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Yes and no. Just because your loan is private and not a bank loan, doesn’t mean you should ignore traditional lending practices commonly referred to as the three “Cs”: Credit, Capacity and Collateral.  Credit refers to the borrower’s past history of paying bills.  Capacity is their ability to make the payment required by the note, and Collateral is the type and equity of the real estate pledged as collateral in the event the loan is not repaid.   So you can see that LTV is just one piece of the three C’s, and should not be the only criterion with which you evaluate a transaction.

Simply using LTV as a loan criterion could lead to irrational decisions if the total loan picture is not considered. For example, which loan would you rather have: a 40% LTV loan on a $100,000 property or a 55% LTV loan on a $1 million home?   If LTV was the only criterion, the 40% LTV would be the logical choice.  But consider that a 40% LTV loan leaves only a $60,000 equity cushion whereas the 55% LTV loan leaves a $450,000 equity cushion.   The larger equity cushion in this example, all other things being equal, is a more logical choice even though the LTV of 55% is the higher of the two LTVs.

Cross collateralization is another reason LTV should not be the only determinant in your investment decision. In the previous example, if the 40% LTV transaction was cross collateralized with a free and clear (debt free)  $500,000 rental property, the loan transaction would become more attractive than the 55% LTV alternative.

Your objective as an investor is to maximize your return and minimize your risk.  LTV is one of many criterions to use, but there is no substitute for evaluating the loan transaction based on a comprehensive consideration of all of the risk factors.

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