LOAN TO VALUE
The Loan to value (LTV) ratio is a term which indicates the ratio of a loan to the value of the asset. LTV is used in the financial sector and is used in particular for building companies. It indicates the amount of the loan in relation to the value of an asset. It is very similar to the lending value which is used as a guideline by banks for mortgages. The LTV is a valuable index number to also determine the credit rating and grant the financing of a real estate acquisition.
Calculation of the LTV ratio:
Loan to Value = credit volume / current market value of the asset x 100
AN INDEX NUMBER WITH VARYING DEFINITIONS
The loan to value index number plays an important role in real estate financing as it indicates the ratio of the loan to the value of the asset. Banks may follow different guidelines in determining the lending value of real estate. A common appraisal is based on the market value determined by an appraiser minus the haircut – a term used to describe the deduction of a security markdown. This security markdown can be set to 20 % for example. This method is also used for determining the loan value. If the LTV makes up 80 %, it will also make up 80 % of the lending value. The market price however will only be used on rare occasions.
The debtor should be aware that each bank has their own criteria for determining the loan to value index. When comparing the conditions of loans from different banks, debtors will realize that the conditions may vary greatly depending on the LTV. Banks generally apply different methods for determining the credit rating of a potential debtor. Due to these different methods, the terms and conditions for a loan may differ from one financial institution to another. Unlike international banks, German banks rarely work with the loan to real estate value. Credit institutions in Germany generally work with the loan value which determines the interest rate of the loan.
THE LOAN VALUE USED BY GERMAN BANKS
A creditor requires a security prior to approving a loan. Generally, a land charge will be registered in the land charge register. The creditor will then have the right to request the sale of the property for the repayment of the loan if the debtor falls into arrears with the payments. This is why banks determine the long-term value of a property prior to granting a loan. The loan value is a long-term index number and will be determined prior to granting a loan. The bank determines the maximum amount of the loan value for which the loan will be granted and uses it as a security for the financing. Financial institutions generally grant a loan amount below the actual loan value. Although the financing of a loan for 100 % of the amount or more is possible, it does entail higher interest rates. The loan value differs from the loan to value ratio as it is defined as the ratio between the granted loan and the percentage of the loan value as an index figure.
In this case example, the financing of a construction requires a loan of 130,000 €. In addition to that, an additional 50,000 € is required for reconstruction works. The total financing requirements make up 180,000 €. According to the loan value, the loan value ratio is set to 0.6 (60 %). Based on this premise, the bank grants a loan of 60 % of the loan value. In theory the loan amount could be increased if an additional loan was required for modernisation works. The loan value could be set to 70 % or 80 %.
It should be noted that the amount of the interest during the construction period is based on the ratio between the loan and the value of the property. A higher ratio will result in increased risks for the bank. An increased interest rate provides a compensation for the bank for bearing these risks. With a desired loan of 60 % there is quite a large selection of credit institutions to choose from. The prospective debtor has the opportunity to select the most attractive loan with the best terms and conditions.
With a loan as high as 80 % - 100 % it is generally more difficult for the prospective debtor to find a suitable financial institution to approve the loan. Only a few credit institutions in Germany grant such high loans. In return, they include an added security premium in addition to the interest rate. These costs result in expensive financing for the debtor. Therefore, prospective debtors are advised to invest as much proprietary capital as possible in order to keep the loan on favourable terms.