HGTV hasn’t come around to offer us a TV show contract yet, but we sure do love our house-flipping business. Just like every other house flipper out there, we’re always looking for the worst house in the best neighborhood that we can fix up into something amazing…and amazingly profitable. But long before we set out the cookies and reel in the prospective buyers, we have to pay for the remodel. And if we don’t have enough cash on hand to, say, buy a $200,000 house and put $50,000 into it, we might consider taking out a loan.
When banks finance projects like our custom home remodels, one of the things they look at is the LTC, or loan-to-cost ratio. Basically, the LTC tells them how much of the total project they’re financing and, for the most part, they won’t agree to finance more than 80% of the total cost. Not only does this protect them a little bit if our project hits the skids, but it also ensures that we the borrower have some skin in the game. After all, even with a full 80% loan, we’re still on the hook for the other 20% right now, even before we start paying back what we’ve borrowed.
So, all that being said, if our estimated project cost is $250,000, the bank probably isn’t going to finance more than $200,000.
Look, we’ll prove it with math:
LTC = LA/PC
LA is our loan amount, and PC is our project cost. So if our PC is $250K and our loan amount is for $200K, we get this:
LTC = 200,000/250,000 = .8, or 80%
This 80% thing isn’t a hard and fast rule. If we’ve maybe got a questionable loan payment or credit history, we might not get approved for that much. The bank might decide it’s safer for them to only approve a loan with a 60% LTC. Or sometimes, if a bank decides to finance more of the project—like 90%, for example—we might end up paying higher interest rates to compensate for the risk, even if our credit score is perfect.
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Finance: What is the Times Covered Inter...23 Views
finance a la shmoop- what is the times covered interest ratio?
okay people. we'll just restate the question if it's simpler. from your [girl frowns in classroom]
operating profits this part of your income statement right here- how many
times is your interest expense covered? still not simple enough? okay how about
this? how big a multiple is your operating
profit of your interest cost? there we set it boom. okay so you run furry nation [definitions listed]
America's finest purveyor of animal bodysuits. the company has two billion
dollars in debt on which you pay six percent interest or 120 million dollars
a year. you really wanted that platinum encrusted fidgets spinner and well you
just couldn't wait. furry nation has revenues of three billion dollars and [hand spins fidget spinner]
conveniently has operating profits of 360 million. so how many times larger is
your operating profit than your yearly interest? well check out the hundred
twenty million dollars error of interest from before, that number gets divided
into the operating profit number. and the answer? three. well why does this ratio [equations]
matter? well the three times interest covered number is a solid indication of
how easily you can pay the interest if not the principle of the debt you have
borrowed. think about a normal boom and bust business cycle. in a bad year your [bridge blows up]
company might shrink to have only two billion of revenues and 180 million
dollars of operating profits. in which case in that dismal year it would have
only one point five times interest coverage. in a great year with say 900
million of operating profit while the coverage ratio would be 6x or 600 [equations]
percent or six times. now put your butt in the seat of the lender. if you're the
one who loaned the two billion dollars at 6% while you're getting pretty
nervous about being able to collect your money back when operating profits are
down to just one point five times. but it's six times interest well you sleep [woman snores in bed]
like a baby happy to keep collecting your interest payment though. so why do
we use operating profits this line here instead of net income or after-tax
profits this line here when we calculate the times interest ratio? well because
interest costs are tax-deductible? they're a cost just like [definitions]
plastic or office building rent or mandatory company yoga retreats. the cost
of renting money is treated for tax purposes really no different from the
cost of renting a building. so we don't worry about taxes when we're focused on
just repaying our debts. just don't try to use that excuse when tax time comes [woman smiles behind desk]
around though. Uncle Sam well he don't play.