Loan to Cost is a ratio we use to determine the loan percentage or amount a lender is willing to finance based on the hard cost construction budget. Once the construction is completed the project will have a new value. We will assume that the future value may be double the construction costs. So if we have a loan for 200K for construction for a future value of 400K after completion then the underwriting for the loan will look like this:
Example: construction costs = 200,000
LTC = 80%
Loan given by lender = 160,000.
Future Value after completion = 400,000
Loan given after completion = 320,000
The lender will not finance all the construction costs as they would want the borrower to have “skin in the game” meaning some equity in the project so that they don’t simply walk away if the deal were to go south.
So a lender may require that they have at least 10 – 20% of the construction costs into the deal.
This scenario does not take into consideration the value of the land. However typically you can expect that we can finance 75% of the purchase of the land, 80% of the hard cost construction budget or 80% of the future value.
Many borrowers assume that once they have their permits and drawings they have increased the value of the property. Which is true, but Lenders see that as a future value and skin in the game for out of pocket soft costs. Ultimately the Lender wants the Borrower to have equity in the project to keep the ball bouncing until the project is completed.