High interest rates are typically cited as the biggest downside to loans from private, or hard money, lenders; however, in actuality, reputable private lenders’ rates are usually not that far off from the long-term average rates for investment property mortgages. Furthermore, most private lenders offer interest-only payment schedules for the loan term, which is typically six months to three years. The other practice that offsets some of the costs of hard money loans is the way hard money lenders calculate loan-to-value (LTV) ratios, which can actually result in the borrower receiving more funds than they would from a traditional lender.

What is an LTV?

Customarily, LTV rates are calculated to offer a certain percentage of a property’s value as the final loan amount. For example, if a lender offers a 65% LTV on a property valued at $500,000, then the loan amount will be $325,000. On the surface, if you just look at the LTV rates, it seems like a bank offering an 80% LTV loan is a better deal than a hard money lender who only offers a loan with a 60% to 65% LTV. However, there is more that borrowers should take into account than simply the LTV ratio itself.

How are LTVs for conventional loans determined?

Banks and other institutional lenders are required by Federal regulations to calculate their loan amounts using the lesser of either the purchase price or the current appraised value. This means that if you have a really good deal on a distressed property that is valued at $500,000, but with a purchase price of only $400,000, then the 80% LTV bank loan will be based on the purchase price and the loan amount will be $320,000. If you perform a direct comparison of this LTV rate with the 65% rate of a private lender, you might think that the private loan amount would only be $240,000, which seems like a bad deal.

How are LTVs for hard money loans different?

While a straight-up comparison of rates (as shown above) makes it seem as though hard money loans are a bad deal, in reality, it’s important to remember that private lenders are not bound by the same Federal regulations and, therefore, are free to choose the value that they want to use to determine the LTV for their loans. Most reputable private lenders will use the higher of the property values rather than the lower. Also, when dealing with distressed properties that the borrower plans to renovate, these lenders will often be willing to use the after-repairs value in lieu of the as-is value. This means that, revisiting the above example, because the private lender uses appraised value (rather than the purchase price as the bank did), the 65% LTV loan amount would actually be $325,000, which is a higher loan amount than the traditional bank would offer. It is possible to actually get a larger loan amount from a hard money lender in spite of the lower LTV ratios.

The actual loan amount for which a borrower qualifies will vary depending on a variety of factors, including the amount of the down-payment, plans for the property or project, and the borrower’s experience with real estate investing. Reputable hard money lenders will be prepared to explain how they calculate LTV ratios for their loans and provide preliminary loan terms to prospective borrowers so that you can be sure of how your loan amount will be determined ahead of time.