Loan to Value: How Much of the Asset the Lender Will Fund

Two amounts sit against one asset: what was lent, and what the asset was valued at. Almost every property this ratio has comes from a single fact about that pair, and it is worth putting on the table before anything else. Only one of the two moves on its own. The loan moves when it is drawn and when it is repaid, and at no other time. The valuationAn assessed amount for an asset at a stated date. How an assessor arrives at it is a separate craft with its own methods, covered separately. moves whenever the asset is assessed again, for causes that sit outside the loan and outside the person who took it.

What is loan to value, and what is it a percentage of?

The fault is already in the sentence people actually say, so start there. Somebody says a loan is at eighty five per cent. Eighty five per cent of what? Of the amount borrowed? Of the money the borrower has put in? Of everything they owe? The sentence has a number in it and no base underneath the number, and until the base arrives the number is not measuring anything.

Loan to value is the loan amount divided by the valuation of the asset, and the base is the valuation. Not the price paid. Not the total the borrower has spent on the asset over the years. Not the sum of every loan the borrower is carrying. One loan, one asset, one assessed amount, and the assessed amount goes underneath.

The everyday version of this sits nowhere near a bank. A cousin says he has paid for two thirds of the van. Two thirds of what? Two thirds of the van, obviously, and everybody in the room supplies the missing half of the sentence without noticing they did it. Put a lakh of rupees on the table instead of a van and the missing half stops being obvious. Four or five candidate bases are lying around and no shared picture forces the right one. So the discipline is to say it out loud every time, in full: this loan, against this valuation.

Take the pair worked with throughout. Suvarna Commercial Bank Limited has lent Rs 51,00,000/- against an asset assessed at Rs 60,00,000/-. The ratio is Rs 51,00,000/- over Rs 60,00,000/-, or 85.0 per cent of that valuation. Nothing in that sentence is left for the reader to supply.

What is the remainder for, and whose is it?

If the lender has funded 85.0 per cent of the valuation, then 15.0 per cent of that valuation came from somewhere else, and the somewhere else is almost always the person who took the loan. On this pair that is Rs 9,00,000/-. The remainder is easy to file away as bookkeeping, an amount that was paid at the start and is now history. The remainder is not history. It is doing a job every single day the loan runs.

The remainder is the amount by which the valuation can fall before the loan is larger than the asset behind it, and that is the reason for calling it a cushion. That is the whole of its function. Not a deposit, not a fee, not a formality at the counter: a measured distance between two numbers, and the distance is what absorbs movement.

Think of loading a cycle rickshaw. The load sits some distance back from the front edge of the platform. Nobody thinks of that gap as cargo. But every bump the rickshaw goes over is taken up by the gap, and the load only starts sliding off when the gap has been used up. The gap was never doing nothing. The gap was doing the only job that mattered.

And the lender is looking at exactly the same number and calling it something else. To the borrower, Rs 9,00,000/- is what they put in. To the lender, the same Rs 9,00,000/- is the distance between what it has lent and what stands behind the lending. That distance is the amount by which the assessed asset can move before its secured exposureThe amount a lender stands to lose on a loan that has an asset attached to it. The amount a lender must hold against such an exposure is covered separately. stops being fully covered by the assessment. One amount, one asset, two people describing it in two vocabularies because they are standing on opposite sides of the same counter.

Which valuation is the ratio struck on?

Now the part that produces most of the wrong answers, and it produces them among people who can do the arithmetic perfectly well. On one loan, on one ordinary Tuesday, three different figures can all be correctly computed and all be correctly called loan to value.

The first is the amount originally lent over the valuation at the time the loan was agreed. The second is the amount still outstandingThe part of a loan still to be repaid. The outstanding amount falls as repayments are made. The schedule of those repayments belongs to other material and is not set out here. over that same original valuation. The third is the amount still outstanding over a valuation struck today. Same loan. Same day. Three answers.

Put these figures through all three. Suppose repayments have brought the outstanding amount down to Rs 43,00,000/-, and the asset has since been assessed again at Rs 54,00,000/-. The original figure was Rs 51,00,000/- over Rs 60,00,000/-, or 85.0 per cent of the valuation at sanction. Rs 43,00,000/- over that same Rs 60,00,000/- is 71.67 per cent of the valuation at sanction. Rs 43,00,000/- over the current Rs 54,00,000/- is 79.63 per cent of the current valuation. The last two figures are 7.96 points apart, and the only thing separating them is which valuation went underneath.

All three are correctly computed, all three are called loan to value, and a reader handed one of them without its two inputs has been handed a number that could be any of the three. Which produces the one habit worth carrying away, and it is a habit rather than a fact. Every time one of these figures is written down, the loan amount and the valuation belong beside it. Not in the paragraph above. Beside it, in the same breath. Then the figure cannot travel without them.

What does a fall in the valuation do, and in what order does it do it?

The loan does not move. The valuation moves. Everything that follows is a consequence of those two sentences sitting next to each other, and the consequence has an order to it. The order is the part worth memorising.

Work it on this pair. The asset was assessed at Rs 60,00,000/- and is assessed again at Rs 54,00,000/-, a fall of Rs 6,00,000/-, or 10.0 per cent of the original valuation. The loan is still Rs 51,00,000/-. Nothing about a revaluationA fresh assessment of the same asset at a later date. How often it must be done, and by whom, is covered separately. repays anything. So the remainder is now Rs 54,00,000/- less Rs 51,00,000/-, or Rs 3,00,000/-. The remainder was Rs 9,00,000/-. The entire Rs 6,00,000/- came out of the remainder and not one rupee of it reached the funded Rs 51,00,000/-.

The cushion goes first, and it goes entirely, before anything at all touches the lender's funded amount. That is the order, and the order is the teaching here rather than the arithmetic. Ask where a fall lands and the answer is never "somewhere between the two of them". The fall lands on the remainder until the remainder is gone, and only when there is no remainder left does the loan become larger than the asset behind it.

The arithmetic is cold and the subject is not, so one thing needs saying plainly alongside it. The order in which a fall is absorbed is a statement about where a cost lands, and it carries no suggestion that anybody in the transaction ought to have expected the valuation to move. Valuations move for reasons nobody at the counter controls and nobody at the counter can see coming. The arithmetic answers one question. Whether the movement was foreseeable, or whether anyone did anything wrong, is quite another.

Why does the remainder fall so much faster than the asset?

Set the two percentages side by side. The juxtaposition is the whole point. The asset fell by 10.0 per cent. The cushion fell by 66.67 per cent. Rs 9,00,000/- became Rs 3,00,000/-, and 66.67 divided by 10.0 is about six and two thirds, so the cushion moved roughly six and two thirds times as far as the thing underneath it. Most people, asked to guess, say a tenth off the asset takes a tenth off the cushion. The tenth takes two thirds of it.

The share of the cushion a fall takes is the size of the fall divided by the share of the valuation the cushion was. Here the fall was ten hundredths of the valuation and the cushion was fifteen hundredths of it, and ten over fifteen is two thirds. The division is the entire mechanism and there is nothing else in it. Both numbers are measured against the same base, the valuation, and that shared base is what allows one to be divided by the other at all.

The general shape follows without any dressing up. The higher the funded share, the thinner the cushion, and the thinner the cushion, the more of it any given movement in the valuation consumes. At 85.0 per cent funded, a tenth off the valuation takes two thirds of the cushion. Push the funded share higher and the same tenth would take more than the whole of it. Push it lower and the same tenth would take less. The movement in the asset has not changed at all across those three sentences; only what it is being measured against has.

The ratio itself moves the other way and along a different sort of line. Rs 51,00,000/- over Rs 60,00,000/- is 85.0 per cent of that valuation and Rs 51,00,000/- over Rs 54,00,000/- is 94.44 per cent of the new one, a rise of 9.44 points. The remainder is a subtraction, so it falls in a straight line as the valuation falls. The ratio is a division by a shrinking number, and so climbs along a curve that gets steeper as it goes. Two things moving out of one movement, at two different rates, is exactly why the relationship is hard to hold in the head.

What does loan to value not measure?

Three questions are regularly put to this ratio that it was never built to answer, and knowing which three prevents more misuse than anything else about it.

The ratio does not measure whether the loan can be repaid. Repayment comes out of income and arrives on an instalment scheduleThe calendar of repayments fixed when a loan is arranged, each one falling on its own date. Whether a borrower can meet such a calendar is judged elsewhere., and the ratio has neither of those things anywhere in it. A loan at a low percentage of a large valuation can be entirely beyond the person paying it, and a loan at a high percentage of a small one can be comfortable.

The ratio does not measure what the asset would actually fetch. A valuation is an assessment made at a date by somebody applying a method. A sale price is settled instead by who turns up, on what day, with how long to think about it. The assessment and the sale price answer two different questions, and the ratio only ever contained the first.

The ratio was struck on one loan against one asset, so it does not measure how much the borrower owes in total. Somebody carrying four loans has four of these figures and no single one of them describes the position. The four cannot be added together. The sum would not mean anything.

A ratio that measures one relationship is not weak for failing to measure three others, and reading it as a summary of somebody's whole position is where it goes wrong. It measures the relationship between one loan and one assessed asset. That relationship is a genuinely useful thing to know and it is all the thing the ratio knows.

What is the lender doing with the same number on its own side?

Everything so far has been written from the counter's near side. Cross it. The same arithmetic is sitting on the lender's desk and it is doing a different job there, and seeing both jobs at once is what makes the number stop feeling arbitrary.

At the moment of lending, the ratio is a limit. The lender is deciding how much it will put against an assessed amount, and the percentage is the form that decision takes. After the lending, the same figure becomes something monitored: recomputed on the lender's own schedule, against whatever assessment it is working from, and fed into what it must hold against the exposure. Suvarna Commercial Bank Limited would be doing exactly that on this loan. So would Rukmini Finance Limited, an invented lender that takes no deposits at all. The arithmetic of an asset standing behind a loan does not care where the lending money came from.

The same arithmetic is doing two different jobs on the two sides of the counter: on one side it describes what has been put in, and on the other it describes what is exposed. And the reason both parties end up watching one percentage is not coincidence or convention. The reason is that the ratio is the only number connecting them. The borrower's income is not the lender's number. The lender's cost of funds is not the borrower's number. The loan against the assessed asset belongs to both of them at once.

A household can use the same figure in a way that has nothing to do with either of those jobs. Recomputed once a year on a fresh assessment, with the two amounts written down beside it, it gives a plain reading of where a particular loan stands against a particular asset. That reading is worth having for its own sake and does not require anybody to do anything about it.

Who decides how much of an asset may be funded?

Six separate requirements sit around everything above, and each of them is set elsewhere. The largest share of an asset's value a lender may fund, differing by class of asset. How the asset must be assessed, and how often it must be assessed again. How much a lender must hold against a loan that has an asset attached. How the lender's chargeA lender's claim over one named asset, written into a public record so that anybody checking that asset can see it. How one is created was settled earlier. over the asset must be recorded and where. The procedure a lender follows before and while acting on the asset. And what the borrower must be told about the valuation, and by when.

A maximum written into a reference would be saying something that is no longer so rather than something dated. A requirement that has been revised does not announce itself on the document that stated the old one. The old statement simply sits there looking exactly as finished and as confident as it did on the day it was right. A live address stays useful however many times the requirement underneath it moves.

So the card below sets each requirement beside the body that fills it, named inside the row. A reader takes away a form to complete from the authority itself. A form is a smaller thing than a filled table and a much longer lasting one.