Loan-to-Value Ratios Explained – Key Insights for You

In India, borrowers can choose different financing options to suit their funding requirements. From unsecured personal loans to secured gold loans and home loans – borrowers can meet specific finance deficits with different types of loans. While unsecured loans are sanctioned with asset pledging, secured loans come with a collateral requirement. For secured loans, lenders use a loan-to-value or LTV ratio metric to determine the appropriate loan amount that can be sanctioned against the pledged asset.

The concept of LTV also applies to secured business loans. While small and micro-enterprises can opt for collateral-free Mudra loan of up to Rs. 10 Lakhs in India, opting for a high-value business loan may bring collateral requirements. Some financial institutions may require collateral pledging for such MSME loans. In such cases, the lender evaluates the market value of the pledged asset to determine if the loan amount requested is feasible and adjusts loan terms accordingly.

What is the Loan-to-Value Ratio?

The loan-to-value ratio determines the maximum amount of money you can borrow with a secured loan based on the asset’s market value pledged as collateral. LTV ratios are common risk assessment tools lenders use to determine loan eligibility in the banking domain. For secured loans, the loan amount sanctioned by the lender is a percentage of the asset’s market value. This ensures that any possible losses from a future default can be covered by simply selling the pledged asset.

Asset-backed business loans can be sanctioned against different assets, including real estate, equipment, stock, inventory, or non-physical assets like outstanding invoices or accounts receivable. Apart from secured MSME loans, LTV ratios are commonly used in home loans and gold loans. Under the former, the lien agreement covers the property bought with the loan, while the lien covers the pledged gold articles in the latter.

How to Calculate  Loan To Value Ratios

To calculate the LTV ratio, simply divide the secured loan amount by the appraised market value of the pledged asset. Multiply the result by 100 to convert the ratio into a percentage. Here’s a snapshot of the LTV formula:

LTV Ratio = Loan Amount / Appraised Asset Value

For instance, if the secured loan amount is Rs. 60,000 and the appraised asset value stands at Rs. 1,00,000, the LTV ratio for the loan will be 60%. For secured business loans, the market value given to certain assets varies depending on the asset in question and the lender’s internal policies. For instance, the lender will lower the market value of an asset if it has low liquidity since it will take the lender some time to liquidate the asset to receive cash. Lenders generally account for this time by lowering the asset’s market value.

Also Read: GST Loan Schemes for MSMEs: A Guide to Financial Support

Decoding Implication of LTV Ratios

LTV ratios significantly impact both the business owner borrowing funds and the lender as well as the lending process. Here’s an overview of low and high LTV ratios for secured MSME loans:

Low LTV Ratios

Lenders perceive lower LTV ratios (typically below 80%) as less risky options. A low LTV suggests enough buffer for the lender to recoup the borrowed funds in the event of a default. Lower LTVs create a more secure lending scenario, ensuring easy eligibility, lower interest rates, and better loan terms for the borrower.

High LTV Ratios

Lenders consider a higher LTV ratio (exceeding 80%) very risky since it implies that the loan amount makes up for the major portion of the asset’s value. This leaves little room for market fluctuations or a decline in the collateral’s worth. Consequently, lenders take precautions to shield themselves against possible defaults with stricter loan terms like higher interest rates or shorter tenures.

LTV Ratios and Loan Eligibility

The LTV ratio determines a business owner’s eligibility for a secured MSME loan. Here’s how LTV ratios correlate to loan eligibility:

• A high LTV ratio lowers your chances of securing the loan. Lenders may be willing to offer the loan but against higher interest rates to shield themselves against potential risks.

• A low LTV ratio boosts your chances of securing the loan. Lenders generally offer better lending terms like lower interest rates since a low LTV ratio creates a more secure lending arrangement.

While LTV ratios have an important role in business financing, it is important to note that loan eligibility depends on several factors. Lenders assess the borrower’s creditworthiness, business cash flow, capital management, and other parameters to decide on eligibility and the sanctioned loan amount.

What is a Good LTV Ratio?

The specific threshold for a ‘good’ or ‘ideal’ LTV ratio can vary among lenders, industries, and the type of loan in question. LTV ratios depend on several factors, like the lender’s risk assessment, RBI directives, the type of asset pledged, the type of ‘value’ used, liquidity of the asset, and prevailing market conditions. Generally, a lower LTV ratio is considered ideal by most lenders across the secured loan spectrum since it offers lenders ample cushioning to prepare for unforeseen circumstances. Moreover, most lenders have maximum LTV caps vis-a-vis different asset types when sanctioning a secured MSME loan. It’s good to be mindful of these caps when determining a reasonable LTV ratio for the lender.

Also Read: MSME/PSB Loans in 59 Minutes Loan

Conclusion

In a nutshell, loan-to-value ratios, or LTV, are pivotal in the secured lending domain. Understanding LTV ratios, how they are calculated, and their implications on loan eligibility is crucial for borrowers pledging assets. Apart from understanding the basics of LTV ratios, business owners seeking secured MSME loans should focus on the lender’s list of acceptable collateral, internal LTV caps, and LTV calculation policies. This way, they can maintain a reasonable LTV ratio and secure financing on favourable terms.

Frequently Asked Questions

What Is a Good Loan-To-Value Ratio?

A good LTV ratio should not exceed the 80% threshold. Ratios higher than 80% mean higher risk for the lender, translating to higher interest rates, shorter repayment duration, and stricter loan terms for the borrower.

What Does A 100 LTV Mean?

A 100% LTV means borrowing a sum equal to the full value of the pledged asset. Loans with a 100% LTV ratio don’t require any down payment from the borrower. However, a 100% LTV is considered highly risky for the lender.

What Is The Ltv Ratio?

LTV ratio or loan-to-value ratio refers to the maximum amount of money that can be borrowed against the asset’s value that’s pledged as collateral. It is essentially the proportion of asset value the lender sanctions as a loan. LTV ratios are crucial for certain types of loans like gold, home, and secured business loans.

What Kind Of Assets Are Accepted As Collateral For Secured Business Loans?

Lenders accept real estate, equipment, inventory, accounts receivable, and other tangible assets as collateral. However, this list can vary depending on your selected lender.

Do Mudra Loans Consider Ltv Ratios?

No. Since Mudra loans are collateral-free loans, LTV ratios have no bearing on loan eligibility and terms.