Every fix and flip term sheet quotes leverage, and most quote it two ways. Investors who are new to renovation lending often read the higher number and plan around it. The loan you actually receive is set by whichever test produces the smaller amount, so it pays to understand both before you sign a purchase contract.
Loan-to-cost: the loan against your total project cost
LTC divides the loan by the total cost of the project. On a flip, total cost is the purchase price plus the renovation budget, and some lenders also count certain closing costs and a contingency line. If you buy for $1.5M and budget $500K of works, the total cost is $2M. At 90% LTC the loan can reach $1.8M, and your cash in the deal is the remaining $200K plus closing costs and carry.
The renovation portion is not paid at closing. It sits in a holdback and is released in draws as the work is completed and inspected. The purchase portion funds at closing.
After-repair value: the loan against the finished property
ARV is the appraiser's opinion of the property's value once the planned works are done, based on comparable renovated sales nearby. The appraiser reads your scope of work and budget, so a vague scope produces a cautious ARV.
Lenders cap the loan at a percentage of ARV as well. That ceiling varies by lender, by market and by your experience, and it is the test that bites when the purchase price is full or the renovation budget is heavy relative to the end value.
How the two tests work together
- LTC asks: do you have enough of your own money in the deal? It is driven by your purchase price and your budget
- ARV asks: is the finished property worth comfortably more than the loan? It is driven by the appraisal
- The lender computes both and lends the lower figure
- A low appraisal therefore reduces the loan even if your costs are exactly as planned
- A cheap purchase with a strong ARV is usually limited by LTC, not by ARV
A worked example
Take the same project: $1.5M purchase, $500K renovation, $2M total cost. At 90% LTC the cost test allows $1.8M.
Now the ARV test. If the appraiser puts the finished value at $2.6M, a $1.8M loan is about 69% of ARV, which leaves a wide margin and the cost test sets the loan. If the appraisal comes in at $2.1M, the same $1.8M would be about 86% of the finished value. Very few lenders accept that, so the loan is reduced and you bring the difference in cash. The project did not change; the expected margin did.
That is the practical reading of ARV: it is the lender's check on your profit margin. A flip where the finished value barely exceeds the total cost is a thin deal whatever the LTC headline says.
What moves each number in your favour
- A detailed scope of work and a contractor bid: they support both the budget (LTC) and the appraiser's ARV
- Renovated comparable sales close to the property, which you can hand to the appraiser
- Completed projects of a similar size: experience is one of the main drivers of how far a lender will go on both ratios
- A realistic contingency in the budget, so a cost overrun does not push you over the ratio mid-project
Where LTV fits in
Loan-to-value (LTV) is the third ratio you will see. It compares the loan to the current, as-is value and applies to a bridge loan on a property that needs little or no work: Passy Capital's bridge loans go up to 80% LTV. When the business plan is a renovation, LTC and ARV are the ratios that decide the loan, and if you keep the property afterwards, a DSCR refinance up to 80% LTV on the finished value is the usual exit.