Loan To Value Real Estate Guide

Sep 1st 2022
Loan to value (LTV) is the ratio of a mortgage loan compared to the value of the property that is being purchased. The LTV ratio is used as a way for lenders to determine how much risk they are taking on when someone applies for a loan. This is important as it determines if and how much a bank will lend and how large of a down payment you'll need.

hash-markLTV Ratio Formula

Financial institutions don’t want to get themselves into trouble by lending large sums of money to borrowers who have no “skin in the game” or are more likely to default on their loan. This is where the LTV ratio comes in, as it determines how much potential equity a borrower has in their home, and therefore how risky lending to them might be. 

If you are interested in purchasing a home and applying for a mortgage, you can calculate the LTV ratio of the house by dividing the amount borrowed by the value of the home. The result is shown as a percentage, and this is the LTV ratio.

For example, let’s say you are interested in a house that has an appraised value of $200,000. Luckily, you’ve been saving for a while and intend to make a down payment of $30,000. This would mean that the amount you would need to borrow from a lender to purchase the property is $170,000.  To calculate the LTV ratio, you would then divide $200,000 by $170,000. Therefore, the LTV ratio for that home would be 85%

hash-markWhat is LTV Used For in Real Estate?

LTV is commonly used by mortgage lenders as a way to compare the size of your mortgage loan to the value of your home. Mortgage lenders will look at the loan-to-value ratio as a way of determining how much risk a borrower poses to their financial institution. You can think of the LTV ratio as an assessment of the risk that a borrower may pose to a financial institution, and typically those with a high LTV will be considered higher-risk loans. 

The LTV ratio will usually be considered during the loan underwriting process when applying for a mortgage, or when refinancing a home. Typically, a higher LTV ratio indicates that a borrower poses a greater risk because they have less equity built up in the home. This means that should they default on the loan and the house goes to foreclosure, the lender may find it harder to sell the property for enough to cover the outstanding mortgage balance. 

hash-markWhat is a Good Loan To Value Ratio?

A higher LTV ratio doesn’t necessarily mean that a borrower will be excluded or unable to secure a loan. But typically speaking, lenders give the lowest interest rates to those with an LTV ratio of 80% or lower. This equates to a 20% down payment on the house. 

A higher LTV ratio will also mean that you are more likely to be required to purchase private mortgage insurance. So, even though it is possible to secure a loan with an LTV ratio that is higher than 80%, paying mortgage insurance could potentially add tens of thousands of dollars on to your loan. A lower LTV ratio will increase your chances of securing a loan and getting the lowest possible interest rate. Some lenders will allow you to borrow with an LTV as high as 97% (requiring only a 3% downpayment), but in this case, you will likely be required to pay mortgage insurance, possibly for the life of the loan.

In the case that the LTV ratio is greater than 100%, the borrower is considered to be “underwater” on the loan. This is when the property’s market value is less than what the borrower owes on the mortgage. This usually happens when property values are falling, or early on in the repayment period if closing costs were especially high. This is not a great situation to be in as it means that the borrower has negative equity. 

hash-markCLTV vs. HCLTV

LTV Ratio is most commonly used when a borrower is first applying for a mortgage, but it can also be used for current homeowners who are looking to refinance. However, if you are refinancing your home with a second mortgage, it’s a bit of a different story. In this instance, just the LTV ratio alone will not be enough for a financial institution to determine their risk. This is because it only includes the primary mortgage and doesn’t take into consideration any additional obligations a borrower might have (such as a second mortgage). 

If you fall into this category, you’ll need to calculate either the CLTV (combined loan to value) or the HCLTV (high combined loan to value). The CLTV measures the combination of both your first and second mortgages against the appraised value of your home. The HCLTV measures your highest possible LTV ratio and is typically only used if you have a home equity line of credit. 

hash-markHow To Lower Your LTV

In general, lowering your LTV ratio has the potential to save you massive amounts of money in the long run. The easiest way of lowering your LTV is to make a larger down payment, as this then reduces the amount that you are borrowing against the property you want to buy. 

However, most people don’t just have the funds stashed away to increase their down payments by tens of thousands of dollars. If this is the case, then you may need to set your sights on more affordable housing options. By doing so, the downpayment that you have will equal a higher percentage of the total sales cost of the house, thus lowering your LTV ratio.

hash-markLTV Bottom Line

LTV ratio is basically a way of telling you how much of your home you actually own, and is essential to lenders when determining the risk that a borrower poses to them. If you are interested in purchasing a home or refinancing your current house, it’s diligent to calculate your own loan-to-value ratio before you approach your lender so that you have a general idea of where you might stand.

Bear in mind that, while LTV ratios are important to financial institutions, they’re not the be-all and end-all of securing a loan. They’re simply part of a bigger picture that includes your income, credit scores, and the property that you are looking at. So, if you do have a higher LTV ratio, don’t give up, it doesn’t mean that you can’t still secure the house of your dreams.