What is a Loan-to-Value (LTV) Ratio?

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What Does Loan-to-Value Mean? 

A loan-to-value (LTV) ratio is a financial risk assessment tool primarily used by mortgage lenders to evaluate your loan eligibility. For a new home purchase, LTV measures the ratio of the desired loan amount compared to the market value of a property. When refinancing an existing loan, LTV measures the ratio between your existing home’s current value vs. how much you owe on your mortgage. 

Lower LTV ratios are less risky for lenders, because it means that they are financing a smaller percentage of the property’s value. Borrowers with higher LTV ratios may face stricter lending criteria and higher interest rates or be required to purchase private mortgage insurance (PMI) to protect the lender in case of default.

Today, we’ll cover how to calculate loan-to-value, why it’s so important, and how it impacts your mortgage terms. 

How to Calculate Your Loan-to-Value Ratio

To calculate your LTV ratio, divide your loan amount by the property’s appraised value. Then, multiply by 100 to express the result as a percentage.

LTV = Loan Amount / Appraised Value x 100  

For example, if you’re purchasing a home worth $375,000 and you’re taking out a mortgage for $325,000, the loan-to-value ratio would be calculated as:

LTV = $325,000 / $375,000= 0.86 x 100 = 86%

In this scenario, the loan is financing 86% of the property’s purchase price, and your down payment would cover the remaining 24% or $40,000. 

Why is Loan-to-Value Important? 

LTV is one of the most critical factors used to determine how risky an investment is for lenders and how much you can borrow on a mortgage loan. The other important factor is your debt-to-income (DTI) ratio. 

You can think of it like this: your DTI ratio tells a lender how well you can handle a mortgage payment, while your LTV ratio tells a lender how much you have invested in your home – this is called equity. 

Home equity and loan-to-value are inversely related, meaning that LTV helps lenders determine the amount of equity the borrower has in a property. The higher your equity in a property, the less risk on the lender’s part if you default. 

To understand how this works, consider two mortgage applicants: one with a 20% down payment and an 80% LTV ratio and another with a 10% down payment and a 90% LTV ratio. 

The applicant with the lower LTV ratio presents a more secure investment for the lender, as they have a greater equity stake in the property upfront. In the event of default and foreclosure, the lender stands a better chance of recouping their investment from the sale of the property, as there is a larger buffer between the loan amount and the property’s value. 

To understand how this works, consider a borrower who wants to purchase a home for $110,000. The borrower uses a $10,000 down payment (10%) and a $100,000 loan to buy the house, making their loan-to-value ratio 90%. 

Say the borrower defaults on the loan soon after purchase, and the lender only receives a total of $15,000 from the borrower—including $5,000 in monthly payments and the initial $10,000 down payment. 

When the lender goes to re-sell the home, they find that it will only sell for $90,000 (a $20,000 decline from its original price) because its appraised value has declined. In this example, the lender would incur a $5,000 loss because the decline in resale price is greater than the payments the borrower had made ($15,000) before foreclosure.

In this same example, let’s say the lender had required the borrower to make a larger down payment of 20% — meaning a lower LTV ratio of 80%. In this case, the borrower puts a $22,000 down payment, cutting the loan amount to $88,000, and when they foreclose, the lender is able to make a $2,000 profit (with a $90,000 selling price). 

This is why it’s better to have a lower LTV ratio. In the case of default, a lender has more cushion than a borrower with higher home equity because they are more likely to recover their investment. 

What is a Good Loan-to-Value Ratio? 

When qualifying for a mortgage, there is no set LTV ratio. However, there are thresholds that lenders generally follow that can differ by loan type. Keep in mind that LTV is also affected by a borrower’s creditworthiness and income.

To Remove PMI

Private mortgage insurance (PMI) is a type of insurance that protects lenders in case a borrower defaults on their mortgage loan. The borrower pays PMI premiums as part of their monthly mortgage payments, and the insurance coverage assures the lender that they’ll be compensated if the borrower fails to repay the loan.

A standard threshold to remove PMI for a purchase loan is reaching an 80% LTV ratio.

For a Refinance

Similar to avoiding PMI on a purchase loan, aiming for an LTV ratio below 80% can often lead to more favorable terms on a refinance, such as lower interest rates and the ability to avoid private mortgage insurance or other similar requirements.

For a HELOC or Home Equity Loan

For a HELOC, lenders may allow higher LTV ratios, often up to 85% or even 90% in some cases.

Similarly, lenders typically prefer lower LTV ratios for a traditional home equity loan, ideally below 80%. However, some lenders may allow LTV ratios up to 85% or slightly higher, depending on their risk tolerance and specific loan programs.

How to Lower Your LTV Ratio

Here are 5 tips you can use to lower your LTV ratio for a purchase loan: 

  1. Increase Your Down Payment: The size of your down payment significantly impacts your initial equity in the home. A larger down payment results in greater equity from the start, as it reduces the amount you need to borrow. A higher down payment can also be useful in waiving PMI payments.

    For example, take a borrower who wants to purchase a home for $400,000 and is trying to avoid paying PMI. If the lender is willing to waive PMI with an LTV of 80% (they pay $320,000), the borrower would have to come up with a down payment of $80,000. 

  2. Negotiate the Purchase Price: The home’s purchase price relative to its appraised value also affects your equity. If you negotiate a purchase price lower than the appraised value or if the property appreciates after purchase, your equity increases.

    For example, if a seller has a home listed for $275,000 but it appraises for $300,000, then you would automatically have an LTV of 92% even if you financed 100% of the home’s purchase price. 
  1. Consider a Less Expensive Property: Consider borrowing less money to purchase a less expensive property. This directly reduces the loan amount and decreases your LTV ratio.
  1. Negotiate Purchase Price: Negotiate with the seller to lower the property’s purchase price. A lower purchase price reduces the loan amount and lowers your LTV ratio.

  2. Improve Your Credit Score: A higher credit score may qualify you for better loan terms, including lower interest rates and a higher LTV allowance.

To qualify for the best loan terms, you should strive for as low of an LTV ratio as possible. The easiest ways to do this are by narrowing your price range, raising funds for a down payment, and shopping around for lenders who offer loans with higher LTV ratios in exchange for good finances. 

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