Imagine being a loan officer for a bank or credit union. Math would be a big part of the job. You would have a lot of calculations, including debt-to-income (DTI) and loan-to-value (LTV) ratios. The two ratios are critical to determining a borrower’s creditworthiness. But what about hard money lending? Do DTI and LTV ratios apply?
Hard money lending is a different kind of lending. It is the domain of private lenders who operate under rules that are quite different to those rules banks and credit unions need to follow. Different rules allow hard money lenders to establish their own criteria for loan approval.
To answer the DTI and LTV question directly, DTI ratios do not apply in hard money lending. LTV ratios do.
DTI and Credit Worthiness
If you own a home, chances are you got a mortgage through a bank, credit union, or mortgage broker. You likely had to provide proof of income and list all your debts. Why? Because the lender needed to determine your DTI ratio. That ratio helped the lender get a decent idea of your ability to make monthly payments.
If your DTI is too high on a new mortgage application, it is assumed you do not have enough disposable income to make payments. Your chances of being approved are pretty slim. But if your DTI falls within prescribed limits, your chances of approval go up. That is pretty much it in a nutshell.
Hard money lenders are not constrained by DTI. Instead, they measure your ability to repay based on the value of an asset you offer as collateral. Should you default on your loan, that collateral can be seized and sold to pay what you owe. As long as your collateral is worth enough to cover what you want to borrow, your DTI is irrelevant.
LTV and Loan Amounts
If you bought a home, you were also subject to the LTV ratio when you applied for your mortgage. In simple terms, the lender was only willing to cover a certain percentage of the purchase price. That percentage is the loan-to-value ratio. The LTV ration on a $75,000 loan for $100,000 house is 75%.
Conventional lenders employ the LTV ratio in order to force borrowers to put some skin in the game. They want borrowers to assume at least some risk as motivation to pay back what they borrow. Conventional loans can have LTV ratios as high as 80-85%.
While hard money lenders have no use for DTI ratios, they do employ the LTV principle. Not only that, but they also do it for the same reason as conventional lenders. Hard money lenders mitigate their risk by forcing borrowers to put up some of their own money.
Interestingly, LTVs in the hard money game are much lower. Salt Lake City hard money lender Actium Partners says they can be as low as 50% in some cases. That is because hard money lenders take more risks. The higher the risk, the lower the LTV. That forces the borrower to put up more of their own money.
It is a Numbers Game
When you look at both DTI and LTV ratios, you need to conclude that it’s a numbers game. When the numbers fall within an acceptable range, loans are more likely to be approved. When they fall outside that range, denials are pretty much guaranteed.
As for hard money lenders, they utilize LTV ratios for their own protection. They have little use for DTI ratios for the simple fact that approvals are based on the value of the collateral borrowers are putting up.
