Loan to Cost – Not All Lenders calculate equally

[Stuart Udis]

I recently had a client come to me looking for assistance securing a construction loan. The client prioritized leverage and was adamant a hard money lender would offer the best terms citing the higher LTC. I frequently see the same rationale used in these forums. I believe there could be other benefits and reasons to use a hard money lender such as transactional ease (depending on lender) or perhaps even as a way of opening doors for borrowers who may not qualify for bank financing. However, when it comes to selecting a lender solely based on leverage it’s important to understand what’s included in each lender’s definition of loan to cost. By way of example, a lender who excludes settlement costs and requires the borrower to fund the interest reserve is vastly different than a lender who includes the settlement costs and an interest reserve that’s capitalized in the loan. Take a look at the following side by side analysis of the sources and uses prepared by two lenders, one who advertised their loan product at 80% LTC and the other at 90% LTC. The lesson here is to understand what each particular lender includes in their Loan to Cost definition because it can have a significant impact on the cash requirements.

[Stuart Udis]

 @John O'Leary I've seen the adjustable LTC based on experience but in my example neither lender adjusted their LTC based on experience. The 90% LTC lender only applied the purchase price and the soft/hard construction costs & contingency to their definition of LTC whereas the 80% LTC lender also financed 80% of the settlement costs and interest reserve. I have seen everything from settlement costs included/not included to interest reserves capitalized (as was the case in my 80% LTC example. I have also seen no interest reserve whatsoever and while the cash needed on day of origination might seem much lower, once applied to the transaction, the cash requirement is actually much higher (albeit partially delayed in being required). The point I was trying to get across is lenders incorporate different project cost line items into their LTC and the lender who advertises the higher LTC, may not actually be the lender who provides the best leverage depending on what portion of the transaction is financed.