The loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of the loan amount to the value of an asset (in this case, commercial real estate) purchased. It is reflects the relationship between property value and loan. Financial institutions use this ratio to assess lending risk. To calculate the LTV ratio, the total amount of the borrower’s obligations to the bank is divided by the total calculated value for the collateral.
The term is commonly used by banks and building societies to represent the ratio of the first mortgage lien as a percentage of the total appraised value of real property. For instance, if a someone borrows $1,300,000 to purchase a property worth $1,500,000, the LTV ratio is $1,300,000 to $1,500,000 or $1,300,000/$1,500,000, or 87%. The remaining 13% represent the “lender’s haircut”, adding up to 100% and being covered from the borrower’s equity. The higher the LTV ratio, the riskier the loan is for a lender.