How Does ARC Capital Assess Risk?
ARC Capital wants to insure that our investors put their money in a well vetted investment. That is why we assess risk using the LTV or Loan-To-Value Ratio as our first go-to. Other important elements we use in assessing risk are credit, income documentation and type of collateral.
What Is A Loan-To-Value Ratio And How Is It Calculated?
Loan-to-value ratio, or LTV, is an important element in evaluating risk. Let’s start out first with how to calculate LTV. It really is pretty simple. You take the amount of the loan and divide it by the total value of the securing collateral.
So let’s say for example that a borrower is buying an investment property worth $100,000. They have $20,000 for a down payment. That means they will need a hard money loan for $80,000. What then is your LTV? You will simply calculate 80,000/100,000 = 0.80. (Loan Amount/Home Value=LTV). Your LTV is 80%!
It is important to note that the home value is not what the borrower is purchasing the house for or what the house was listed for on the market. The home value is the appraised or current market value.
The higher the LTV, the higher the risk for the loan; the investor will have to lend larger sums of money. This is usually due to the fact that borrowers with high LTV properties have less invested in that property. Take the above example, if a borrower only has $20,000 of their own money invested in a property they are more likely to just walk away if financial crisis hits. However, if they have $50,000 invested, making the LTV 50%, they are less likely to walk away. It’s all about how much “skin you have in the game”.
Why Is The Loan-To-Value Ratio So Important?
All investors lend their money in good faith that the borrower will pay their loan as agreed. However, in those rare cases that doesn’t happen the investor wants to be able to recover their money plus any legal/administrative fees incurred during the process.
The real estate market fluctuates. Home values go up and home values go down. There is no way to 100% accurately predict what the market is going to do. Therefore, the lower the loan-to-value ratio, or LTV, the more likely the investor can sell the securing collateral for the loan amount or more even with the fluctuating real estate market.
This is why LTV is such an important component in assessing risk.