What is Loan to Value?

Are you in the market for a new home? Are you wondering if you will qualify for a mortgage? If so, there are many terms to familiarize yourself with, including loan to value.

What is Loan to Value?

Buying a home is one of the biggest decisions you will ever make, and the process that you follow will have an impact on your financial situation now and in the future.

In the content to come, we are going to discuss the finer details of loan to value ratio, as this always moves to the forefront when applying for a mortgage and purchasing a home.

In addition to discussing the ins and outs of loan to value, we'll provide you with detailed information on:

  • How this is calculated
  • Why it is important
  • The difference between a good and bad loan to value ratio
  • How it relates to private mortgage insurance

You don't have to be a lending professional to understand loan to value and how it can impact your purchase and financial circumstances.

What is Loan to Value?

Loan to value is exactly what it sounds like: this is the amount of the loan required by the borrower divided by the value of the asset. This is commonly used when buying a home, as the loan to value gives the lender and borrower a clear view of the risk involved.

An example of a loan to value would be a person who is borrowing $100,000 to purchase a $200,000 home. This equals a loan to value of 50 percent.

What is Loan to Value Ratio?

The loan to value ratio (LTV) is a calculation that a lender uses when deciding on a mortgage application.

As complicated as it sounds, this does nothing more than express the ratio of a loan to the value of an asset, such as a home.

Calculating the loan to value ratio is as simple as dividing the desired mortgage amount by the appraised value of the property.

An example of this would be a person who borrows $150,000 to purchase a $200,000 home. In this case, the loan to value ratio is $150,000/$200,000 or 75 percent.

As a lending risk assessment, the loan to value ratio gives the lender a better idea of the risk, they are taking when lending money.

Generally speaking, the higher the loan to value ratio the higher the risk. This is why a loan to value ratio greater than 80 percent typically requires the borrower to purchase private mortgage insurance.

Loan to Value calculator

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Combined Loan to Value Ratio

The combined loan to value (CLTV) ratio is another calculation used by lenders. This calculates the total percentage of a property encumbered by all liens, not just the first mortgage.

This ratio is calculated by adding the balances of all loans and dividing it by the market value of the home. An example of this would be a property with both a first mortgage and a home equity loan.

An example of this would be a home with a first mortgage of $100,000 and a home equity loan of $50,000, with a total value of $200,000. This equals a CLTV of 75 percent.

Note: CLTV typically comes into play when a current homeowner wants to secure another loan, such as home equity line of credit. It is also common in the event that a homebuyer wants to take out a second mortgage at the time of purchasing a home, as opposed to making a down payment.

What Does LTV Tell a Lender?

Mortgage lenders don't want to extend risky loans to homebuyers, as this can come back to haunt them in the event of a default.

The loan to value ratio is not the only thing that enters into play when securing a mortgage, but it's something that lenders use to assess risk.

Most lenders offer the lowest possible interest rate to people with a loan to value ratio of 80 percent or less. Along with this, a ratio in this range means that the borrower does not have to pay private mortgage insurance.

A higher loan to value ratio does not mean that a lender will reject an application, but it does result in a greater level of risk. For example, a borrower with a loan to value of 90 percent may receive approval. However, the lender will charge a higher interest rate as a means of mitigating their risk.

How is this Calculated? What is the Formula?

Lenders provide mortgages based on a variety of details, including the loan to value ratio of the home. Even if you have no experience buying a home, it will only take you a few minutes to calculate your loan to value ratio.

The first thing you need to do is negotiate the price of a home (or receive an appraisal). Once you have this number in place, you can turn your attention to your down payment.

An example of this would be $100,000 (price of the home) - $20,000 (down payment).

From there, divide the mortgage amount by the selling price and convert it to a percentage.

$80,000 / $100,000 = 0.80 or 80%. This is your loan to value ratio.

If you find that your loan to value ratio is too high to qualify for a mortgage (or to obtain the lowest rate), there are two things you can do:

  • Buy a cheaper home (or negotiate a lower price)
  • Increase your down payment

Why Your LTV Ratio is Important

This number may not be a big deal to you, but your LTV ratio comes into play when applying for a mortgage.

Generally speaking, the lower your LTV ratio, the greater chance you have of receiving approval. Also, a lower ratio typically qualifies you for a lower rate.

Borrowers with a lower LTV ratio are looked at as less risky, as they start with more equity in their home. Even if this person would default, the lender has a better chance of selling the home for at least (or more) the remaining balance of the mortgage.

Note: different lenders have different requirements in regards to your LTV ratio, making it necessary to shop around for the best loan.

What is a High or Low LTV Ratio? What's Good?

Since every lender has different requirements, there is no simple way of saying what's high and low in regards to a LTV ratio. Furthermore, this is not the only detail that a lender considers when making a final decision.

A high LTV ratio may be considered 90 to 100% by some lenders. This doesn't necessarily mean that you will not be approved for a loan, but it could result in a higher interest rate.

A low LTV ratio is typically anything 80% or below, as this is when private mortgage insurance begins to phase out (more on this below).

You should discuss this detail with your lender, as it will give you a better idea of what they look for in regards to your LTV ratio.

From there, you can tweak the numbers, such as the amount of your down payment, to make them work in your favor.

How the LTV Ratio Relates to Private Mortgage Insurance (PMI)

Simply put, your LTV ratio is what determines if you are required to pay private mortgage insurance. This is additional money added to your monthly amount, so it's important to understand if this will be tacked onto your payment for the time being.

With a conventional loan, you will need a down payment of 20% or more to avoid private mortgage insurance. This means your LTV ratio will be 80% or less.

With an FHA loan, however, you can have a LTV ratio as high as 96.5% without having to pay private mortgage insurance.

Tip: even if you start out paying private mortgage insurance, you can request that your lender reassesses your situation once you have at least 20 percent equity in your home.

Conclusion

When shopping for a home and applying for a mortgage, it's important to know the ins and outs of your loan to value ratio. With this detail in mind, you'll have a better idea of how much home you can afford, the amount you need for a down payment, and how to avoid private mortgage insurance.

If you have any questions about loan to value ratio, don't hesitate to consult with several mortgage lenders. This is one of the best ways to learn more about this detail, including how it will factor into your application and interest rate.

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