What Is a Loan-To-Value Ratio and Why It Matters?
Loan-to-Value ratio (LTV) is a crucial factor that lenders consider when assessing your mortgage application. It measures the mortgage amount’s ratio to the property’s value. It is evaluated during various stages of home ownership, such as buying or selling a home, renewing or refinancing a mortgage, or getting a home equity loan.
This article will delve deeper into what LTV is and why it matters.
What Is a Loan-to-Value (LTV) Ratio?
Loan-to-value (LTV) ratio measures the lending risk that lenders evaluate before approving a mortgage. It compares the loan amount a borrower wants to borrow against the appraised value of the property they want to buy. A higher LTV ratio indicates a higher risk of default, and loans with high LTV ratios are considered riskier.
The LTV ratio shows how much of a property a borrower truly owns compared to how much they owe on loan taken to purchase it. Along with LTV, lenders consider other factors such as credit score, income available for monthly payments, and the condition and quality of the asset being purchased. Good credit makes it easier to get higher LTV loans.
How to Calculate LTV Ratio?
To calculate the loan-to-value ratio for a home purchase, you need to divide the loan amount you seek by the appraised value of the property you want to buy.
For example, you want to buy a house appraised at $300,000. You plan to put down a down payment of $60,000 and take out a mortgage of $240,000. To calculate the LTV ratio, divide the mortgage amount ($240,000) by the appraised value of the property ($300,000) and then multiply by 100 to get a percentage. In this example, the LTV ratio is 80%. It means that you are borrowing 80% of the property’s appraised value, and your down payment covers the remaining 20%.
Understanding the Use and Impact of LTV: Acceptable Loan-to-Value Ratios
LTV ratios below 80% are considered less risky and can help you with the easy loan approval. If a lender approves a mortgage with a higher LTV ratio, a higher interest rate may be charged, and the borrower may be required to purchase private mortgage insurance (PMI) to offset the risk to the lender. Thus, lenders use LTV ratios to determine loan approval and whether mortgage insurance is necessary.
Here are a few examples of loan types that may have different rules when it comes to LTV ratio requirements:
- FHA Loans: The Federal Housing Administration (FHA) offers loans to help low-income and first-time homebuyers qualify for mortgages. Borrowers can generally qualify for an FHA loan with an LTV ratio of up to 96.5%, but they will be required to pay mortgage insurance premiums (MIP) throughout the life of the loan.
- Jumbo Loans: Jumbo loans are mortgages that exceed the conforming loan limit set by the Federal Housing Finance Agency (FHFA). Because jumbo loans are riskier for lenders, they often require lower LTV ratios than conforming loans. Borrowers may need a down payment of at least 10-20% to qualify for a jumbo loan.
- Home Equity Loans: Home equity loans allow homeowners to borrow against the equity they have built in their homes. The amount a homeowner can borrow is usually limited to a percentage of the home’s value, with LTV ratios typically ranging from 80% to 90%.
- VA Loans: VA loans are mortgages guaranteed by the Department of Veterans Affairs and are available to eligible military service members, veterans, and their spouses. VA loans often allow for higher LTV ratios than conventional loans, and borrowers may be able to qualify for a VA loan with no down payment.
Importance of Loan-to-Value Ratio for Lenders and Borrowers
- Lenders can use the LTV ratio to manage their portfolio risk by limiting the amount of high LTV loans they are willing to extend.
- For borrowers, the LTV ratio can provide a measure of equity in the property, which can be essential for future refinancing or borrowing against the property.
While no specific LTV ratio threshold guarantees loan approval, having an LTV ratio close to an acceptable percentage can increase your chances of being approved for a loan. Overall, it helps both parties to determine the most favorable loan terms.