Loan to Value Ratio Explained for Borrowers

A loan to value ratio (LTV) describes the size of a loan compared to the value of the property being purchased. It is used to determine how risky a loan is. The higher the LTV ratio is, the riskier the loan.

Financial institutions will examine an LTV to determine whether or not to approve a mortgage for home buyers. Essentially, the LTV tells you how much of a property you actually own versus how much you owe.

This guide will help you understand how to calculate the LTV ratio and why it is important.

How to Calculate LTV

LTV is calculated by dividing the amount of a loan by the appraised value of a home.

Example: Let’s say you are buying a home valued at $100,000 and make a $10,000 down payment. You will need to borrow the remaining $90,000.

Calculation: 90,000/100,000 = 0.90 or 90%

This means that you truly own 10% of the property and still have to pay off the remaining 90%.

What Is a Good LTV Ratio?

A good LTV ratio depends on the type of loan you are applying for:

Conventional Mortgage

An LTV ratio of up to 80% is considered good for a conventional mortgage loan. Ratios of 80% and under will help homebuyers secure low mortgage interest rates and favorable terms. Buyers must make a 20% down payment to achieve this. Although 20% down has long been considered the golden standard, research shows the average in recent years is much lower.

FHA Loans

Federal Housing Administration (FHA) loans have a completely different set of standards. With an FHA loan, a borrower must make a down payment of at least 3.5%. Therefore, an acceptable LTV ratio is 96.5%. However, with a down payment that small, borrowers must buy mortgage insurance which protects lenders in case the buyer defaults.

USDA and VA Loans

Certain United States Department of Agriculture (USDA) and Veteran Affairs (VA) loans do not require a down payment, so your LTV ratio can be as high as 100%. In order to qualify for these types of loans, you will have to meet specific qualifications such as income requirements, property location, or military status.

Why Your LTV Ratio Is Important

As a borrower, here are some ways your LTV ratio could affect you:

• Higher Interest Rate: If you have a higher LTV ratio, you may have to pay a higher interest rate on your loan. The higher monthly payments will add up as time passes and make a sizable difference in the total amount of your loan.
  
• Private Mortgage Insurance: If your LTV ratio is too high, lenders will require you to purchase private mortgage insurance (PMI). Adding PMI will raise your monthly payments. It typically costs between 0.5% to 1% of the entire loan amount on an annual basis.
  
• Getting Approved for a Mortgage: The riskier your loan appears to be to lenders, the harder it will be to get approved for a mortgage. Lenders favor lower LTV ratios because the borrower has more of an equity cushion.
  
• Equity in Your Property: A higher LTV ratio means you have less equity in your property. This can be an issue for lenders because if you default, they might not be able to recover their losses by selling the property. Putting down a larger down payment so the LTV ratio is lower can set you up to build more equity in your home.
  
• Refinancing: If you wish to refinance your mortgage, a lower LTV ratio will qualify you for more favorable terms.

Ways to Lower Your LTV Ratio

There are ways to lower your LTV ratio to put you on track for a better financial situation.

Higher Down Payment: Increasing your down payment to lower your LTV will help you in the long run. If you are short on cash, consider waiting until you have saved enough to make a sufficient down payment.

Reappraisal: Homes generally appreciate over time and there are certain factors that may cause a property’s value to increase significantly. A reappraisal can paint a more accurate picture of the equity you have in your property and let you know if your LTV ratio has decreased.

Final Word

The LTV ratio is one of the most important factors lenders consider when deciding whether to approve a loan for a mortgage. For a low mortgage rate, it is a good idea to make a sufficient down payment so you will have a lower LTV. A lower LTV ratio means you have greater equity and will help you save money throughout the course of your loan.