What Is Loan to Value Ratio? It’s the Key to Getting a Good Mortgage

September 20, 2019

loan to value ratio

StockImages_AT/iStock

The loan-to-value ratio (LTV) is a crucial factor if you’re buying a home and applying for a mortgage. So what exactly is this loan-to-value ratio, or LTV? An LTV ratio is simply the amount of money you borrow from your lender, divided by the purchase price of the home, and expressed as a percentage.

For example, let’s say the home you have your eye on is worth $250,000, and you plan to make a down payment of 20% of the home’s price, or $50,000. That would mean you need a loan amount of $200,000. That would also mean your LTV ratio would be $200,000/$250,000 = 0.8, or 80%.

The whole loan-to-value conversation may still seem confusing, so hang with us. You’re about to become an LTV expert, so get ready to dazzle your friends with a little loan-to-value brilliance.

Why the loan-to-value ratio matters

Lenders use LTV ratios to determine the risk level they face loaning money to a prospective client. The higher a client’s LTV, the greater the odds are deemed to be that this borrower might stop paying the monthly mortgage fees and default on the loan.

This could spell less favorable mortgage terms and interest rates for a hopeful home buyer, which is why the LTV ratio is such an important figure. It’s not the only factor involved, though. Credit scores are also considered when it comes time to calculate a mortgage rate.

“Borrowers who have a higher loan-to-value ratio are considered more risky to lenders, because they have less equity in their homes,” explains Keith Gumbinger, vice president of HSH.com, a mortgage information resource.

In other words, that lack of home equity translates to less skin in the game. For instance: Let’s say you make a down payment of only 10%, or $25,000, on that home worth $250,000. That would mean you need a loan amount of $225,000, which would also mean your loan-to-value ratio would be $225,000/$250,000 = 0.9, or 90%.

Most conventional private lenders like banks require that borrowers have an LTV ratio of 80% (or lower) before they approve a loan. This effectively means that the buyers need to make a 20% down payment. Home buyers with a higher LTV (and lower down payment)—often first-time home buyers or those with credit-score issues—may be deemed too risky and be denied a mortgage.

Alternatively, lenders might approve the loan for a high-LTV client, but at a higher interest rate (more risk, more reward). They also might require that the buyer purchase private mortgage insurance (PMI) to cover the lender should the borrower default. PMI is typically required for conventional loans with down payments of less than 20%. Just be aware: If you’re a high-LTV client, private mortgage insurance will almost certainly be mandatory. It’s not the end of the world; keep in mind that there are still ways to outsmart your LTV ratio.

How to lower your loan-to-value ratio

There are two ways to lower your loan-to-value ratio to get good terms on a home loan. That’s right—your LTV ratio is not set in stone.

The first is to make a larger down payment. At least 20% will generally lower your LTV to within a range found to be desirable by mortgage lenders. The other strategy for rehabbing your ratio, of course, is to buy a cheaper house to achieve a more favorable LTV. So, if you have only $25,000 for a down payment, buy a home worth $150,000. That would mean your mortgage amount would be $125,000, and that your LTV would be $125,000/$150,000 = 0.83, or 83%.

When in doubt, talk to a lender or Realtor® to discuss your options. Ideally, this should be before you start house hunting and seeing if you can get pre-approved. This way, you will know what’s within your budget and where you fall on the LTV spectrum. The loan-to-value calculation is a crucial one in the home-buying process, so it makes sense to head into the home-buying process fully educated about your LTV ratio. You can also crunch the numbers with this mortgage calculator.

—————

Watch: What Your Mortgage Broker Wishes You Knew

The post What Is Loan to Value Ratio? It’s the Key to Getting a Good Mortgage appeared first on Real Estate News & Insights | realtor.com®.

You Might Also Like