What is Loan to Purchase Price?
Loan to Purchase Price (LTPP) is a real estate underwriting ratio that compares the size of a requested loan and the property purchase price.
How to Calculate Loan to Purchase Price (LTPP)
Loan to purchase price (LTPP) is a real estate underwriting metric that compares the size of a requested loan from a borrower and the purchase price of the property.
The loan to purchase price ratio (LTPP) 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 price ratio (LTPP) 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 LTPP 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 (LTV) ratio, the loan to purchase price (LTPP) 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 loan to purchase price ratio (LTPP), the more credit risk is associated with the requested financing (and vice versa).
Loan to Purchase Price Formula (LTPP)
The formula to calculate the loan to purchase price (LTPP) 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
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We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Loan to Purchase Price Calculation Example (LTPP)
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 (LTV) 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 price (LTPP) ratio can be determined by dividing the loan amount by the purchase price.
Upon inputting our assumptions into the loan to purchase price (LTPP) ratio formula, we arrive at an LTPP ratio of 87.5%.
- Loan to Purchase Price (LTPP) = $1.4 million ÷ $1.6 million = 87.5%
In conclusion, the loan to value (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 loan to purchase price (LTPP) ratio, which could be a potential red flag.
