Loan to cost vs loan to value on a fix and flip

The short answer

Loan to cost (LTC) is the loan divided by what the project costs you. Loan to value (LTV) is the loan divided by what the property is worth. On a flip, the value is often the after-repair value, or ARV, so you will also see it called loan to ARV.

Many flip lenders set both kinds of limit on the same loan, and you get the lower amount. That is the whole game. The gap between what the deal costs and what the lowest cap allows is cash you bring to closing. Run both numbers before you make an offer, not after the term sheet arrives.

The formulas

Loan to cost = loan ÷ total project cost. On most flip quotes, total project cost is the purchase price plus the rehab budget.

Loan to value = loan ÷ property value. Before the work, the value is the as-is value. After the work, it is the after-repair value, so loan to ARV = loan ÷ ARV.

Max loan = the lowest of every cap on the term sheet, each turned into dollars. Cash for the purchase and rehab = purchase price + rehab − max loan. Closing costs, points, interest, and holding costs come on top of that.

What counts as cost, and what counts as value

Cost is what you pay. Value is what an appraiser says the house is worth. They are different numbers, and lenders get to define both. One lender counts only the price and the rehab. Another adds closing costs or permits. Ask, and write the answer down.

Value has a catch on a purchase. Fannie Mae's rules for conventional mortgages measure purchase LTV against the lower of the sales price or the appraised value. If the appraisal comes in under your price, the loan shrinks and your down payment grows. Some flip lenders size the purchase part of the loan the same way, so ask yours.

Lower-of rules show up in mainstream renovation lending too. On Fannie Mae's HomeStyle Renovation purchase loans, LTV is the loan divided by the lesser of the as-completed appraised value or the purchase price plus total renovation costs. That is loan to cost and loan to value in one rule, and the lower one wins.

Example

Illustrative example. These are made-up numbers and made-up loan terms, not a real house or a real lender's quote. You buy a house for $200,000, plan $60,000 of rehab, and expect an ARV of $320,000. Total project cost is $260,000. The lender's sample terms: up to 90% of the purchase, 100% of the rehab, and a total loan of no more than 70% of ARV.

Cap 1, the cost side. 90% of $200,000 is $180,000. Add 100% of the $60,000 rehab and the cost-based loan is $240,000. That would be about 92.3% loan to cost ($240,000 ÷ $260,000).

Cap 2, the value side. 70% of the $320,000 ARV is $224,000.

The lower cap wins, so the loan is $224,000. That is about 86.2% loan to cost ($224,000 ÷ $260,000) and exactly 70% loan to ARV. Cash for the purchase and rehab is $260,000 − $224,000 = $36,000. If you had planned on 90% and 100% alone, you would have budgeted $20,000. The ARV cap adds $16,000 you need to find.

Now the appraisal comes in low, at $300,000 instead of $320,000. 70% of $300,000 is $210,000, so cash for the purchase and rehab jumps to $50,000. When the ARV cap binds, every $10,000 the ARV drops adds $7,000 to the cash you bring.

Add a third test. If the term sheet also caps total loan to cost at 85%, that cap is $221,000 (85% of $260,000). It is lower than the $224,000 ARV cap, so it becomes the binding cap, and your cash for the purchase and rehab is $39,000.

Then add what the loan does not cover. Two points on the $224,000 loan (the ARV-capped case) are $4,480 at closing. At 11% interest-only, charged on the full loan from day one, interest is about $2,053.33 a month, or $12,320 over six months. Buyer closing costs, holding costs, and a reserve for overruns come on top of that.

Second example: a better buy

Illustrative example. Same made-up lender terms, a different made-up house. You buy for $150,000, plan $40,000 of rehab, and expect an ARV of $300,000. Total project cost is $190,000.

The cost side allows $135,000 (90% of the price) plus $40,000 (all of the rehab), or $175,000. The ARV cap allows $210,000 (70% of $300,000). The lower number is the cost side, so the loan is $175,000. Loan to cost is about 92.1%, loan to ARV is about 58.3%, and your cash for the purchase and rehab is $15,000, just the 10% you put down on the price.

That is less than half the $36,000 the first house needs, on a smaller project, because the price left room under the ARV. If this lender also capped loan to cost at 85%, the loan would be $161,500 and your cash $28,500. Read every cap on the term sheet.

Which cap will bind on your deal

It comes down to the spread between what you pay and what the house will be worth. A thin spread means the ARV cap binds and you bring more cash. A wide spread means the cost caps bind, and the loan covers more of the project.

You can find the tipping point. In the first example, the cost-based loan is $240,000. The ARV cap matches that only when 70% of ARV equals $240,000, which is an ARV of about $342,857. Below that ARV, the value side sets the loan.

With these sample terms only, there is a neat link to the 70% rule. Using the terms in these examples (90% of the price, 100% of the rehab, a 70% ARV cap), if you pay no more than the 70% rule's maximum offer, the cost-based loan always comes in at or under the ARV cap. The second house was bought under that line, at $150,000 against a maximum of $170,000, and the ARV cap never came into play. The first house was bought above its line of $164,000, and the ARV cap cut the loan. Change the lender's percents and the link changes with them.

Loan to value after the flip

If you keep the house instead of selling it, the next loan is usually sized on loan to value. A rental refinance or a DSCR loan looks at the appraised value, the rent, and the payment. Once any waiting period has passed, the appraisal, not what you spent, usually sets the loan.

That waiting period matters. Many lenders want you to own the house for several months before they will size a refinance off the new value, and inside that window they may use your purchase price or total cost instead. The BRRRR refinance guide covers that seasoning wait and how it changes the cash you get back.

Common pitfalls

Reading 90% and 100% as the loan. Those are cost caps. The ARV cap or a total loan-to-cost cap can cut the loan below them, and a low appraisal cuts it again.

Comparing two lenders' headline percents when they measure different things. One quotes a percent of cost, the other a percent of ARV. Turn every cap into dollars on the same deal, then compare.

Leaning on a hopeful ARV to make the loan work. When the ARV cap binds, the lender's appraisal sets the loan, not your estimate. Use closed, comparable sales and plan on the low end of the range.

Forgetting that rehab money comes in draws. Flip lenders often pay the rehab after work is done and inspected, so you may need cash to start the job before the first draw arrives.

Counting the loan as all the cash you need. Points, fees, interest, closing costs, holding costs, and overruns come from you, even on a loan that covers most of the project.

Run your own numbers

Work out the caps above, then take the binding loan amount to the calculators. The hard money loan calculator turns that loan, the rate, the points, and the months into monthly interest, points in dollars, and total interest. The fix and flip calculator shows net profit, cash needed, and total-cost ROI. Its free version lends 90% of purchase plus rehab. The full version lets you size the loan on purchase price, purchase plus rehab, or ARV, so you can match the cap that binds.

Not sure of the inputs? The ARV calculator gives a value from square feet and a price per square foot you choose, the rehab cost estimator gives a rough repair base, and the 70% rule calculator shows the maximum offer for your ARV and repairs. None of these pages is a loan offer or an appraisal. They make the math fast, so you know your number before the lender tells you theirs.

Sources

Fannie Mae Selling Guide, B2-1.2-01, Loan-to-Value (LTV) Ratios, https://selling-guide.fanniemae.com/sel/b2-1.2-01/loan-value-ltv-ratios. On a purchase, LTV divides the loan by the lower of the sales price or the current appraised value.

Fannie Mae Selling Guide, B5-3.2-02, HomeStyle Renovation Mortgages: Loan and Borrower Eligibility, https://selling-guide.fanniemae.com/sel/b5-3.2-02/homestyle-renovation-mortgages-loan-and-borrower-eligibility. On a purchase, LTV divides the loan by the lesser of the as-completed appraised value or the purchase price plus total renovation costs.

Backflip, LTC, LTV & LtPP: Loan to Cost vs Loan to Value in Hard Money, https://backflip.com/explaining-ltc-ltv-ltpp-loan-to-cost-in-hard-money/. A flip lender's own explanation of purchase, cost, and ARV caps on one loan, and that the borrower receives the lower amount.

Consumer Financial Protection Bureau, What is a loan-to-value ratio and how does it relate to my costs?, https://www.consumerfinance.gov/ask-cfpb/what-is-a-loan-to-value-ratio-and-how-does-it-relate-to-my-costs-en-121/. Defines LTV and explains that lenders use it to decide how much you can borrow.

Ambition Lending, Fix and flip loans, https://ambitionlending.co/fix-flip-loans-hard-money-lender/. 90% of purchase, 100% of rehab, total loan capped at 75% of ARV; the lowest limit wins.

CambridgeHomeLoan, Fix and Flip Loans, https://www.cambridgehomeloan.com/fix-and-flip-loans/. Loan is the lowest of an LTC cap, 90% of purchase, 100% of rehab, and 75% of ARV.

Unitas Funding, Draw Request Procedure, https://unitasfunding.com/draw-request-procedure. Rehab draws reimburse work already completed and are released after a third-party inspection.

Steps

1. Get every cap in writing

   Ask the lender for each limit on the term sheet: the percent of the purchase, the percent of the rehab, any total loan-to-cost cap, the cap as a percent of ARV, and which value it uses for each.

2. Add up the cost the lender counts

   For most flip quotes that is the purchase price plus the rehab budget. Ask whether closing costs, permits, or a contingency count as cost too.

3. Turn each cap into dollars

   Multiply each percent by its base: purchase percent times price, rehab percent times budget, LTC cap times total cost, and ARV cap times ARV.

4. Take the lowest number

   The lowest result is the most the lender will fund. That one cap is the one that binds on this deal.

5. Subtract the loan from the total cost

   Purchase price plus rehab minus the loan is the cash you put into the house and the work.

6. Add the costs the loan does not cover

   Buyer closing costs, points, lender fees, interest, holding costs, and a reserve for overruns all come from you. Add them before you decide you can afford the deal.

Questions