How to Calculate the Loan to Purchase Ratio
Loan to purchase (LTP) is a real estate underwriting metric that compares the size of a requested loan from a borrower and the purchase price of the property.
LTP is virtually identical to the loan to value ratio (LTV), aside from the denominator, the property purchase price.
Unlike the loan to value ratio (LTV), the loan to purchase ratio divides the size of the loan by the original purchase price of the property, rather than the property’s current appraised fair value.
Therefore, the LTP ratio is not impacted by fluctuations in the fair value of the property (and market pricing), i.e. the purchase price does not change regardless of market conditions and changes in the fair value of the property.
But similar to the loan to value ratio, the loan to purchase price ratio is a method to gauge the riskiness of a proposed borrowing and is used as part of loan sizing by lenders.
Based on the risk profile of the borrower and the surrounding circumstances, such as the amount of financing requested, the lender will size the loan appropriately to reduce their downside risk and the potential to lose their original capital in the event of default.
The higher the LTP ratio, the more credit risk is associated with the requested financing (and vice versa).
Loan to Purchase Formula
The formula to calculate the LTP is the ratio between the loan amount and the purchase price.
Where:
Loan Amount → The requested loan amount by the borrower
Purchase Price → The purchase price of the property on the original purchase date
LTP Calculation Example
Suppose a real estate lender is analyzing the risk of a requested loan, in which the borrower is requesting a loan of $1.4 million. The original purchase price of the commercial property – which will secure the loan if approved – was $1.6 million. The appraised property value, as of the current date, is $2 million. Therefore, the change in the property value is an increase of $400k (or a 25.0% increase).
Loan Amount = $1.4 million
Property Price = $1.6 million
Appraised Property Value = $2.0 million
The loan to value ratio can be computed by dividing the loan amount by the appraised property value, which comes out to 70.0%.
Loan to Value (LTV) = $1.4 million ÷ $2.0 million = 70.0%
The 70% LTV ratio is on the higher end, but the loan could still be approved based on the other factors being considered in the underwriting process. In comparison, the loan to purchase ratio can be determined by dividing the loan amount by the purchase price. Upon inputting our assumptions into the loan to purchase ratio formula, we arrive at an LTP ratio of 87.5%.
Loan to Purchase (LTP) = $1.4 million ÷ $1.6 million = 87.5%
In conclusion, LTV ratio is technically more reflective of the current, fair value of the property. However, the fair value of the property can still fluctuate and converge closer to the LTP ratio, which could be a potential red flag.
