The Loan to Value (LTV) Ratio is an assessment of loan risk that financial institutions and other lenders look at before approving a mortgage. Generally, assessments with high LTV ratios are at higher risk. This means that if the mortgage is approved, the loan costs more to the borrower.
Additionally, a loan with a high LTV ratio may require the borrower to purchase mortgage insurance to offset the lender’s risk.
- 1 Loan to Value Ratio: Formula and calculation
- 2 LTV Ratio and Loan Underwriting
- 3 Factors Affecting the LTV Ratio
- 4 Loan to Value and interest rates
- 5 Types of loans and LTV ratio
- 6 Ranking the Loan to Value Ratio
- 7 Loan to Value Ratio vs. Combined LTV (CLTV)
- 8 Limitations of the Loan to Value Ratio
- The Loan to Value (LTV) Ratio or loan-to-value ratio is often used in mortgage loans to determine the amount needed for a down payment. Also, to find out if a lender will grant credit to a borrower.
- When the loan-to-value ratio is at or below 80%, most lenders offer the lowest possible interest rate.
- Fannie Mae’s HomeReady and Freddie Mac’s Home Possible mortgage programs for low-income borrowers allow for a 97% LTV ratio (3% down), but require mortgage insurance until the ratio drops to 80%.
Loan to Value Ratio: Formula and calculation
Home buyers can easily calculate the LTV of their home.
LTV ratio = MA / APV
MA = Mortgage amount
APV = Appraised Property Value
The process involves dividing the total amount of the mortgage loan by the total purchase price of the house. For example, a home with a purchase price of $200,000 and a total mortgage loan of $180,000 results in an LTV ratio of 90%. Conventional mortgage lenders typically offer better loan terms to borrowers who have an LTV ratio of no more than 80%.
The LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage. For example, if you buy a home valued at $100,000 at its appraised value and make a down payment of $10,000, you will borrow $90,000, resulting in an LTV of 90% (ie 90,000/100,000).
LTV Ratio and Loan Underwriting
The Loan-to-Value (LTV) ratio it’s a critical component of mortgage underwriting, whether it’s buying a home, refinancing an existing mortgage into a new loan, or lending against equity in a property.
Lenders evaluate the LTV ratio to determine the level of risk exposure they assume when taking out a mortgage. When borrowers request a loan for an amount equal to or close to the appraised value, and therefore with a higher LTV ratio, lenders perceive that there is a higher probability that the loan will default because the accumulated principal in the property is little or none. If a foreclosure occurs, the lender may have difficulty selling the home for enough to cover the outstanding mortgage balance and make a profit on the transaction.
Factors Affecting the LTV Ratio
The main factors that influence LTV rates are down payment, sales (contract) price, and appraised value. To achieve the lowest (and best) LTV ratio, increase the down payment and try to lower the selling price.
Using the example above, suppose you buy a house that is valued at $100,000 but the owner is willing to sell it for $90,000. If you make the same $10,000 down payment, your loan is only $80,000, resulting in an LTV ratio of 80% (ie 80,000/100,000). If you increase your down payment to $15,000, your mortgage loan is now $75,000, resulting in an LTV ratio of 75% (ie 75,000/100,000).
Loan to Value and interest rates
While the LTV ratio is not the only determining factor in securing a mortgage, it does play a substantial role in the cost of the loan. In fact, a high LTV ratio may prevent you from qualifying for a loan or refinance option in the first place.
Most lenders offer mortgage and home equity applicants the lowest interest rate possible when the LTV ratio is at or below 80%. A higher LTV ratio is not a disqualification for a mortgage, although the total cost of the loan increases as the LTV increases. A borrower with a 95% LTV ratio, for example, may be approved, but the interest rate may be up to one percentage point higher than for a borrower with a 75% LTV ratio.
Also, yesIf the LTV ratio is greater than 80%, you will likely need to purchase private mortgage insurance (PMI), which can add between 0.5% and 1% of the total loan amount on an annual basis. A 1% PMI on a $100,000 loan, for example, would add $1,000 to the amount paid per year or $83.33 per month. PMI payments continue until the LTV ratio is 80% or less. The LTV ratio will decrease as you pay off the loan and the value of your home increases over time.
Requiring an LTV ratio of 80% (or less) to avoid PMI is not required by law, but is the practice of almost all lenders. Exceptions are sometimes made for borrowers with high incomes, less debt, or other factors such as a large investment portfolio.
Types of loans and LTV ratio
Certain types of loans have special rules regarding the LTV ratio.
FHA loans, which allow an initial LTV ratio of up to 96.5%, require a Mortgage Insurance Premium (MIP) that lasts as long as you have that loan, no matter how low the LTV ratio is. Most people refinance to a conventional loan once the LTV reaches 80% to eliminate the MIP.
VA and USDA Loans
VA and USDA loans (available to current and former military or those in rural areas, respectively) do not require private mortgage insurance although the LTV ratio can be as high as 100%. However, both VA and USDA loans have additional fees.
Fannie Mae and Freddie Mac
Fannie Mae’s HomeReady and Freddie Mac’s Home Possible mortgage programs for low-income borrowers allow for a 97% LTV rate (3% down), but require mortgage insurance until the rate drops to 80%.4 5
Streamlined refinancing options, which waive appraisal requirements (meaning the home’s LTV ratio doesn’t affect the loan), exist for FHA, VA, and USDA loans. For those with an LTV greater than 100% (also known as “underwater” or “upside down”), Fannie Mae’s High Value Loan Refinancing Option and Freddie Mac’s Enhanced Relief Refinancing are available, which are designed to replace the Refinancing Program of HARP which expired on December 31, 2018.
Ranking the Loan to Value Ratio
An LTV ratio of 80% or less is considered good for most home loan scenarios. VA and USDA loans allow up to 100% LTV and avoid private mortgage insurance, although other fees apply.
For most refinancing options, unless you’re applying for a cash refinance, the LTV ratio doesn’t matter, so there’s no such thing as “good” or “bad.” If you’re applying for a cash refinance, an LTV of 90% or less is considered good.
Loan to Value Ratio vs. Combined LTV (CLTV)
The LTV ratio considers the impact of a single mortgage loan when buying a property. and hehe combined loan-to-value ratio (CLTV or Combined Loan To Value) is that of all loans secured on a property with the value of the same.
Lenders use the CLTV ratio to determine a potential homebuyer’s risk of default when using more than one loan, for example, if they will have two or more mortgages, or a mortgage plus a home equity loan, or a line of credit (HELOC or Home Equity Line Of Credit). In general, lenders are willing to lend at CLTV ratios of 80% and above to borrowers with high credit ratings.
The LTV ratio considers only the primary balance of the mortgage. Therefore, in the example above, the LTV ratio is 50%, which is the result of dividing the primary balance of the mortgage of $100,000 by the value of the home of $200,000. Primary lenders tend to be more generous with LTV requirements.
Considering the example above, in the case of foreclosure, the primary mortgage holder receives their money in full before the second mortgage holder receives anything. If the value of the property falls to $125,000 before the borrower defaults, the primary mortgage holder receives the entire amount owed ($100,000), while the second mortgage holder only receives the remaining $25,000 at despite being owed $50,000. The primary lien holder bears less risk in the event of a decline in property value and therefore can afford to lend at a higher CLTV.
Limitations of the Loan to Value Ratio
The main drawback of the LTV is that it only includes the principal mortgage owed. Does not include other obligations such as a second mortgage or home equity loan. Therefore, the CLTV is a more inclusive measure of a borrower’s ability to repay a mortgage loan.