Loan-to-Value Ratio Explained

When you’re buying a home, you’re likely to hear a lot of terms, some of which you may be unfamiliar with. One of those might be the loan-to-value ratio or LTV.

LTV is a comparison between the amount of the loan you hope to borrow against the appraisal value of the property you’re trying to buy. Lenders use this comparison to determine the level of risk a loan is for them, as they’re deciding to approve or deny it. The LTV is also used to determine if you’ll need mortgage insurance.

The higher your LTV ratio, the more risk a lender might see.

A loan-to-value ratio provides details about how much of a property you own versus what you owe on the mortgage you used to buy it. While LTV is most frequently for mortgages, it’s sometimes used for car loans and refinancing too.

A lender will not just look at an LTV. Lenders also consider various factors like your credit score, the income you’d have available to make payments each month, and the condition of the asset you’re trying to buy.

If you have good credit, then you’re in a better position to get higher LTV loans. If you have a high LTV ratio, then you might either be denied approval or you might have a higher interest rate. You may also be required to buy mortgage insurance, which offsets some of the lender’s risk.

How is the Loan-to-Value Ratio Calculated?

You can calculate your own LTV ratio. You take the mortgage amount and divide that by the appraised property value, and it’s expressed as a percentage.

If you were to buy a home with an appraisal value of $100,000 and then put down $10,000, you’d borrow $90,000. That leaves you with an LTV ratio of 90%. If you were to make a down payment of $20,000 instead, you’d have an LTV ratio of 80%.

The idea here is that the more money a lender gives you, the greater your LTV ratio and the more risk they’re taking on.

Collateral and LTV

If the calculation of LTV is factoring into a loan, the loan probably involves collateral. In the case of a mortgage, the loan is secured by a lien. That lien is there as you pay off your mortgage. Your lender can take possession of your home and foreclose on it if you don’t make payments. A lender’s goal isn’t to seize property, but collateral is a way to make sure they can get at least some of their money back if you default on the loan.

If a lender only gives you 80% of the property value, the thought is that they can sell the home even at a discount and still get their money back.

If you got a loan that was more than the value of the asset you were trying to buy, that’s negative equity. Negative equity means an LTV ratio of more than 100%. In that particular situation, it’s an underwater loan.

What Should An LTV Ratio Be?

Most lenders want to see an LTV ratio of around 80% for a mortgage. If you borrow more than 80% of the value of a home, again, you’re probably going to have to get private mortgage insurance to give your lender some sort of protection. Once you get below 80% LTV, your lender will usually let you cancel the insurance.

If you get an FHA loan, you may only have to make a 3% down payment, which would put your LTV ratio at 97%. You’d have to pay mortgage insurance, potentially for the duration of your loan.

When you get a home equity loan, you’re using the value of your home and increasing the LTV ratio. Your LTV goes down if the value of your home goes up.

In the mortgage lending process, there’s no surefire answer as to what your LTV ratio needs to be. Instead, the closer you can get it to an acceptable percentage, the better, but there are a lot of other factors that play into the lending decision aside from this one.

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