Loan-to-Value Ratio: Easy Calculation Guide with Examples and Tips

The Loan-to-Value (LTV) ratio is an important metric that lenders use to assess the lending risk, especially when seeking financing for your startup. It represents the percentage of the loan compared to the market value of the asset you're using as collateral. A lower LTV ratio indicates that you have more equity in the asset, which can lead to better loan terms, such as lower interest rates and reduced down payment requirements, which are critical when managing cash flow in a growing business. 

In India, the loan market is experiencing substantial growth, with the value of loans increasing by 13% in September 2024 compared to the previous year. Additionally, loans to the industry grew by 8.5% in July 2024, as reported by the RBI, highlighting a strong demand for financing in areas such as hospitality, tourism, and healthcare. 

Furthermore, the Indian startup ecosystem is flourishing, with 1,28,000 startups, showcasing the increasing accessibility of capital. As loans become more available, understanding the LTV ratio becomes crucial for securing the best possible loan terms. 

This guide will provide a step-by-step breakdown of calculating the LTV ratio, complete with real-world examples tailored to the Indian market. We’ll also explore tips on maintaining a healthy LTV ratio, ensuring you’re in the best position when applying for loans. By the end, you’ll clearly understand how this ratio affects your financing options, empowering you to make strategic financial decisions.

‍

Why Lenders Use the Loan-to-Value Ratio

In India, lenders rely on the Loan-to-Value (LTV) ratio to assess lending risks. A lower LTV ratio indicates the borrower is making a larger down payment, reducing the lender’s risk. On the other hand, a higher LTV ratio signifies more risk for the lender. If a borrower defaults on the loan, the lender may not recover the total amount by selling the collateral.

With funding for Indian startups surging by over 53% in the first eight months of 2024, it’s crucial for those seeking financing to understand how lenders view LTV ratios. This growth highlights the need for lenders to evaluate these ratios and the associated risks carefully. By doing so, they ensure they do not exceed the collateral's value, effectively safeguarding their investments.

For businesses looking to secure loans, being aware of the LTV ratio can help them negotiate better terms and improve their chances of approval. A strong understanding of how this ratio works can also position companies favorably in the eyes of lenders. 

‍

How to Calculate Loan-to-Value (LTV) Ratio

The Loan-to-Value (LTV) ratio is an essential measure lenders use to assess risk when providing loans, particularly in real estate and business financing. This straightforward calculation indicates how much of an asset’s value is financed through a loan. By understanding the significance of the LTV ratio, business owners can make informed decisions during the loan application process, ultimately enhancing their chances of securing favorable financing.

LTV Ratio Formula

The formula for calculating the LTV ratio is straightforward:

‍

This formula enables lenders to assess the risk tied to the loan by comparing the loan amount with the asset's appraised value.

Example Calculation:

Let's break this down with an example. Suppose a startup is valued at ₹1 crore, and it seeks a loan of ₹70 lakh to expand its operations. Here’s how you calculate the LTV ratio:

Loan Amount: ₹70 lakh

Appraised Value: ₹1 crore

LTV Ratio = (70,00,000 / 1,00,00,000) × 100
                = 70%

This means the loan covers 70% of the property’s value. An LTV of 70% suggests a lower risk for many lenders, as the borrower retains 30% equity in the property's value. This equity acts as a buffer, providing the lender with added security.

Different Ways to Determine LTV

The fundamental formula for LTV remains consistent, but lenders often tailor their calculations to align with specific industry practices. Here are some common adjustments they make to LTV based on the context:

1. Minimum Equity Requirement:  

The concept of minimum equity requirements often applies when securing business loans or investments. Lenders might require a specific percentage of equity before approving financing. For example, if a lender requires a 5% equity stake from the startup, this effectively sets the maximum LTV at 95%. This means the startup must contribute at least 5% of the project’s value to qualify for the loan. The formula adjusts to reflect this requirement, ensuring both parties maintain a balanced risk exposure. 

• Calculation: If the minimum equity required is 5%, the LTV is calculated as ( 1 - 0.05 = 0.95 ) or 95%.

2. Maximum Risk Appetite:  

For a manufacturing company looking to secure funding for equipment, understanding how lenders assess risk is crucial. In industries that finance commercial machinery, lenders often incorporate a "risk buffer." This buffer helps ensure they can recover their investment, even if they need to sell the equipment at a lower price in a hurry.

Let’s consider an example. A manufacturing firm approaches a lender to fund the purchase of a new piece of equipment. The lender, to safeguard their interests, evaluates the possible resale value of the equipment. If they believe that, in a quick sale, the equipment might need to be sold at a 25% discount, they would set a maximum Loan-to-Value (LTV) ratio at 75%. This way, the lender is financing 75% of the asset’s value while leaving a 25% buffer to account for potential depreciation or quick-sale conditions.

How It Works: If the equipment is valued at ₹1 crore, the lender’s calculation would be:

LTV Ratio = 1 - 0.25 = 0.75 (or 75%)

Maximum Loan Amount = ₹1 crore × 0.75 = ₹75 lakh

By setting the LTV at 75%, the lender ensures that if they need to sell the equipment quickly, they have a cushion to cover potential losses. For the manufacturing company, this means access to essential capital to acquire machinery, boost production, and scale operations, while lenders remain confident in the safety of their investment.

• This approach strikes a balance helping manufacturers grow without overexposing lenders to unnecessary risk. 

3. Cash Flow: 

When a company seeks a business loan, lenders carefully evaluate several key factors to determine the loan amount. They examine the company's projected future cash flows and overall financial health. This assessment includes a detailed 'creditworthiness' evaluation, where lenders analyze revenue forecasts, operational costs, and repayment obligations to establish a present value.

Next, lenders calculate the Loan-to-Value (LTV) ratio by comparing the maximum loan amount they are willing to offer to the appraised value of the company’s assets used as collateral. These assets can include equipment, inventory, or commercial real estate. By assessing these factors, lenders can make informed decisions about the loan terms and conditions they offer.  

• Calculation: The present value of future cash flows becomes the loan amount. The LTV is then computed as 

This gives the percentage that reflects the lender's willingness to finance based on the property’s cash flow potential.

How LTV Affects Borrowers

For those seeking loans, the LTV ratio is crucial in determining loan eligibility, amounts, and interest rates. Here’s how it impacts borrowers:

• Approval Chances: A lower LTV ratio enhances the likelihood of loan approval since it signals reduced risk for the lender. This principle applies to various types of loans, including home, vehicle, and business financing.
• Interest Rates: Individuals with a lower LTV ratio often receive more favorable interest rates. Lenders view them as less risky, allowing for loans at a lower cost. Conversely, a higher LTV ratio may lead to increased interest rates.
• Down Payment Requirements: A higher LTV ratio typically means a smaller down payment is needed. However, this also signifies taking on more debt, which can lead to higher monthly payments.
• Private Mortgage Insurance (PMI): When the LTV ratio is elevated, lenders may require borrowers to obtain mortgage insurance to mitigate the risk. This additional expense can increase the overall cost of borrowing.

‍

Factors Affecting LTV Ratio Calculation

1. Type of Asset

The LTV ratio is significantly influenced by the type of asset being financed. Lenders evaluate the risks linked to various business assets, affecting the maximum LTV they are prepared to offer.

Equipment and Machinery:

For companies seeking loans to finance equipment or machinery, lenders typically offer LTV ratios ranging from 50% to 75%. This is because the value of equipment can fluctuate based on technological advancements and market demand. For example, if a piece of machinery is valued at ₹50 lakhs, a lender may provide up to ₹37.5 lakhs.

Inventory:

When financing inventory, LTV ratios generally range from 20% to 50%. Lenders assess how marketable the inventory is and its turnover rate. For instance, if a company has inventory valued at ₹30 lakhs, lenders may offer a loan of up to ₹15 lakhs, considering the risks involved in holding that inventory.

Accounts Receivable:

Lenders may consider accounts receivable as collateral, typically offering LTV ratios between 50% to 70%. The LTV will depend on the reliability of the customer base and the average collection period. For instance, if a company has ₹20 lakhs in receivables, it could potentially secure a loan of ₹10 lakhs to ₹14 lakhs. 

2. Creditworthiness

Creditworthiness is a crucial element in determining the LTV ratio, primarily assessed through the borrower’s credit score. In India, these credit scores range from 300 to 900 and are monitored by agencies like CIBIL (Credit Information Bureau India Limited). A higher credit score indicates better creditworthiness, which can positively influence the loan terms and LTV ratio a lender is willing to offer.

High Credit Score: Borrowers with a credit score above 750 are often perceived as low-risk, which can result in a higher LTV ratio. For example, a manufacturing company with a solid credit history may qualify for up to 90% LTV on a loan to purchase new machinery or equipment. The lender trusts that a creditworthy borrower is more likely to repay the loan on time, minimizing the risk of default.

Low Credit Score: A lower credit score (below 650) signals higher risk to lenders. Lenders may lower the LTV ratio to mitigate potential losses in such cases. For instance, a manufacturing company with a lower credit score, say around 600, might be offered an LTV of only 70-75% on equipment valued at ₹1 crore. This would mean the company needs to provide a larger down payment to offset the perceived risk, ensuring the lender’s investment is adequately protected. 

3. Market Conditions

Market conditions play a crucial role in determining the LTV ratios that lenders are willing to extend to various businesses. These conditions can cause fluctuations in asset values, which directly affect the amount of financing that companies can secure.

Sector Performance

In a robust economic environment, industries like technology and manufacturing often see a surge in demand for their products and services. When businesses in these sectors seek financing for equipment or machinery, lenders may offer higher LTV ratios, sometimes reaching 70% to 80%. This increased confidence stems from the perceived value of the assets and the ability of these companies to generate revenue.

Economic Downturns

During economic downturns, many sectors may experience reduced demand, leading to a decline in asset values. For instance, a manufacturing company facing decreased orders may find that the value of its machinery also drops. In such situations, lenders often tighten LTV ratios, offering lower percentages, around 50% to 60%, to protect themselves against potential losses from asset depreciation.

Market Trends

Emerging market trends, such as a shift toward sustainability or digital transformation, can influence LTV ratios as well. Companies investing in innovative technologies or sustainable practices may find lenders willing to extend higher LTV ratios, recognizing these assets as valuable in a changing market. Conversely, if a trend loses momentum, lenders may reassess the value of related assets, leading to stricter LTV ratios.

Industry Risks

Different industries present varying levels of risk based on market volatility. For example, companies in cyclical industries may encounter lower LTV ratios during uncertain times, reflecting the increased risk associated with revenue fluctuations. This could lead to LTV ratios being reduced to 50% as lenders aim to mitigate potential risks.

4. Loan Terms

The length and terms of a loan significantly influence the LTV ratio. Lenders assess the risk differently for short-term versus long-term loans.

Short-Term Loans: Lenders typically impose stricter LTV ratios on loans with shorter repayment periods, such as personal or business loans lasting between 1 and 5 years. The quicker repayment timeline reduces the lender's risk exposure. To encourage more equity from the start, the LTV ratio might be capped lower. For instance, a business loan secured against inventory with a 3-year term may have an LTV limit of 50%.

Long-Term Loans: For startups, long-term loans, especially those with repayment periods of 5 to 10 years for purchasing equipment or expanding facilities, can offer higher Loan-to-Value (LTV) ratios, often reaching 80% to 90%. The extended repayment period allows startups to manage larger loan amounts, as the monthly installments are spread out over a longer duration. However, to balance the higher LTV, lenders may charge higher interest rates on these loans, ensuring they mitigate their risk while providing startups the capital they need to grow. 

5. Down Payment

The size of the down payment directly impacts the LTV ratio, reflecting the borrower’s financial commitment to the asset.

Larger Down Payment: A larger down payment decreases the loan amount and, consequently, the LTV ratio. In India, lenders typically require a minimum down payment of 20% for home loans, resulting in an LTV ratio of 80%. If a borrower can provide a 30% down payment, the LTV ratio drops to 70%. This lower ratio is favorable to lenders as it signifies reduced risk of default; borrowers with more equity in the property are less likely to default.

Smaller Down Payment: For startups, opting for a smaller down payment can increase the Loan-to-Value (LTV) ratio, which raises the lender’s risk. This is especially true for high-value loans, such as those for purchasing specialized machinery, equipment, or even commercial real estate. To mitigate this risk, lenders in India might insist on larger down payments, ensuring that the LTV ratio stays within acceptable limits. 

For high-value loans, lenders may set stricter terms, especially if the borrower is a new or less established startup. In such cases, where credit history might be limited or less favorable, a larger down payment could be required to secure the loan. This practice ensures that lenders have sufficient collateral coverage, reducing their exposure while still enabling startups to access essential capital for growth and expansion. 

‍

Importance of LTV in Loan Applications

Grasping the Loan-to-Value (LTV) ratio is crucial for anyone navigating the loan application process. In India, those seeking loans for business expansion or property purchases need to understand how LTV influences their financial position and the terms of their loans. Let’s explore why LTV is so important.

1. Influence on Loan Terms: Interest Rates, Tenure, and EMI

Here's how it impacts each element:

Interest Rates: A higher LTV means the borrower is financing a larger portion of the property's value, which increases the lender's risk. As a result, the lender may charge a higher interest rate to compensate for this increased risk. For instance, if the LTV exceeds 80%, lenders might impose slightly higher interest rates than loans with LTVs under 80%. 

In contrast, a lower LTV (around 60-70%) indicates that the borrower has more equity in the property, suggesting a lower risk. This often leads to more favorable interest rates in India, though the difference varies depending on market conditions, lender policies, and the borrower's creditworthiness.

Tenure: For startups seeking loans for assets like machinery or commercial property, the Loan-to-Value (LTV) ratio can significantly affect the loan tenure. A lower LTV ratio might allow for extended repayment periods, making monthly payments more manageable for the business. For instance, Indian lenders might offer loan tenures of up to 10 years for commercial loans when the LTV is conservative (around 70-75%). Conversely, if the LTV is high—meaning the startup is borrowing a larger percentage of the asset's value—lenders may limit the loan tenure to mitigate risk. This could lead to shorter repayment periods and, consequently, higher monthly installments, which may strain the startup's cash flow. Thus, businesses must consider how LTV decisions can impact both immediate financing needs and long-term financial planning. 

EMI: The EMI amount directly relates to the interest rate and tenure. A high LTV usually means higher monthly payments because of the increased interest rate and possibly shorter loan tenure. Managing these higher EMIs could strain the cash flow for a startup founder, affecting business operations. Conversely, a lower LTV results in lower EMIs, making it easier to plan monthly expenses and allocate funds toward other business needs.

2. Borrower's Equity: Higher Down Payment Reduces LTV

The borrower's equity in the property is crucial for the lender's risk assessment. A higher down payment means more equity and a lower LTV. Here’s why this matters:

Risk Reduction: Lenders in India view borrowers with more equity (lower LTV) as less risky. This is because the borrower has a more significant stake in the property and is less likely to default. For example, paying 30-40% of a property’s value upfront gives the lender confidence that the borrower is financially stable. By maintaining a low LTV, a founder can not only demonstrate financial strength but also sidestep the need for Private Mortgage Insurance (PMI), which often kicks in when the LTV exceeds 80%. Avoiding PMI can save founders from extra monthly costs—money that could be better invested back into growing their startup. 

Skipping Certain Loan Costs: A low LTV can allow borrowers to avoid specific fees. For example, lenders might waive property inspections or appraisals if the LTV is below a certain threshold. This can reduce upfront costs and make the loan process smoother and more affordable. 

Flexibility in Future Financing: Higher property equity provides more flexibility in future financial planning. A lower LTV allows refinancing options at more favorable terms if the borrower needs additional funds. For example, if a startup requires a cash influx, having an existing loan with a low LTV could make it easier to secure a further loan or line of credit.

3. Assessing Loan Amount: Aligning with Lender's Policies

In India, lenders have specific policies regarding the maximum LTV ratio they can offer, often dependent on the type of loan:

Housing Loans: Banks typically cap the LTV at 75-90% for home loans. A high LTV near this limit means the borrower has less equity in the property, leading lenders to apply stricter loan terms, such as higher interest rates or shorter tenures. Startup founders looking for a property loan must carefully calculate their LTV to ensure they fall within the lender's guidelines. This can also influence the amount they need to prepare for a down payment.

Commercial and Business Loans: Lenders may have more conservative LTV caps, sometimes around 60-75% for commercial properties or business loans. This ensures the borrower has a significant equity stake, reducing the lender's risk exposure. A high LTV in this context could result in outright rejection of the loan application or a request to increase the down payment to lower the LTV to an acceptable level.

Impact on Loan Approval: A high LTV may complicate the loan approval process. When the LTV is high, lenders conduct thorough due diligence, scrutinizing the borrower's financial health, creditworthiness, and repayment capacity. This could mean providing additional proof of income or cash reserves to convince the lender of your ability to manage the higher monthly payments. In contrast, a lower LTV often speeds up the approval process, as lenders view these loans as less risky.

Recommended Read: Explore the various funding options available for your startup! Dive into our comprehensive analysis to find the best financing solution tailored to your needs.

Why LTV Ratios Matter

The RBI's LTV guidelines serve multiple purposes. Firstly, they protect the lender by ensuring the borrower has a significant investment in the property. For borrowers, these guidelines indicate how much of the property’s cost can be financed, helping them plan their finances effectively. A higher LTV means a smaller down payment, which is helpful for first-time home buyers or those with limited savings. 

Conversely, a lower LTV reduces the loan amount, potentially leading to lower monthly installments and interest costs. Understanding these LTV limits can be crucial for startup founders and business owners, especially if they plan to finance property purchases for either residential or business purposes. Knowing how much can be borrowed based on the property’s value helps with budgeting and ensures compliance with banking regulations.

‍

Merits and Demerits of High LTV Ratio

Merits of a High LTV Ratio

1. Higher Funding: A high LTV ratio allows borrowers to access more significant loan amounts. This means you can secure a more substantial home loan without investing a significant amount upfront.

2. Better Property Options: A higher loan amount allows you to consider a broader range of properties. This opens up possibilities for purchasing homes in better locations or with more desirable features.

3. Resource Allocation: A reduced down payment means you can allocate your resources to other investments. Instead of tying up a large sum in a property, you can invest in business ventures or savings for future needs.

Demerits of a High LTV Ratio

1. Higher EMIs: One downside of a high LTV ratio is that it results in higher Equated Monthly Installments (EMIs). Since you're borrowing more, your monthly payments will also increase, impacting your monthly budget.

2. Possible Higher Interest Rates: Lenders may charge higher interest rates for high LTV loans. This reflects the increased risk they assume, which translates to more cost over the loan's duration.

3. Risk of Default: Borrowers with high LTV ratios face a greater risk of defaulting on their loans. Repaying a larger loan can become challenging if property values drop or if you encounter financial difficulties.

4. Reduced Bargaining Power: With a high LTV ratio, you may have less leverage when negotiating loan terms. Lenders may view you as a higher risk, limiting your options for better rates or terms.

‍

Strategies to Manage Your Loan-to-Value (LTV) Ratio

Managing your Loan-to-Value (LTV) ratio is crucial for securing favorable home loan terms and ensuring financial stability. Here are effective strategies to help you optimize your LTV ratio:

1. Make a Larger Down Payment

Increasing your down payment is one of the most straightforward ways to reduce your LTV ratio. A higher down payment means you borrow less, which lowers your LTV and reduces the lender's risk. 

For instance, if you purchase a property worth ₹50,00,000 and make a down payment of ₹10,00,000, your loan amount would be ₹40,00,000, resulting in an LTV ratio of 80%. By increasing your down payment to ₹15,00,000, your loan decreases to ₹35,00,000, bringing the LTV ratio down to 70%. This reduction can lead to lower interest rates and decreased monthly EMI payments, saving you significantly over the loan tenure.

2. Choose More Affordable Properties

Selecting a property within a more affordable price range can help keep your borrowing needs manageable, thereby lowering your LTV ratio. For example, if your budget allows for a down payment of ₹8,00,000, opting for a property priced at ₹40,00,000 will result in an LTV ratio of 80%. 

This approach not only makes your loan more manageable but also minimizes the need for additional costs like mortgage insurance. While this might mean compromising on certain features of your dream home, it ensures that a more significant portion of the purchase price is covered by your savings, enhancing your financial security.

Additional Tips

• Regularly Save for Your Down Payment: Consistently setting aside funds can help you accumulate a larger down payment over time, directly impacting your LTV ratio.
• Improve Your Credit Score: A higher credit score can lead to better loan terms and lower interest rates, indirectly benefiting your LTV ratio.
• Monitor Property Values: Monitoring the real estate market can help you choose the right time to buy, ensuring you get the best value for your investment.

‍

Conclusion

The Loan-to-Value (LTV) ratio isn't just a number it's a key factor that can shape your financing options, especially for startup founders and business owners. Managing a healthy LTV can unlock more favorable loan terms, reduce the need for costly insurance, and ensure you're on solid ground with lenders. By keeping your LTV in check, you're not only increasing your chances of approval but also optimizing your business's cash flow and long-term financial planning.

For founders looking to secure the best financing for their business, Recur Club can be your partner. With access to over 100 lenders and personalized guidance, we help simplify your funding journey and ensure you get the best terms available. Let Recur Club be part of your growth story!