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What Is Loan-To-Value Ratio (LTV) & How Does It Impact Your Mortgage?

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Loan to value ratio, or LTV, is an important financial concept that comes into account when you are taking out a loan. It is a key factor in many lending decisions and is used to determine the risk associated with a loan, and to calculate the interest to be charged to the borrower.  It’s one of the most important factors weighed by the lender before approving your loan application. In addition, the type of property, credit score, and prime rate also affect the rate when you are purchasing, or refinancing a real estate property.

In this blog, we will discuss what LTV is, how it is calculated, and why it is so important in the mortgage lending process.

LTV (Loan to Value) in Real Estate:

The loan-to-value ratio is a measure of how much your home is worth compared to how much you want to borrow. This figure is expressed as a percentage and is mostly used by lenders in real estate transactions to:

  • Calculate the risk they are taking by lending the money.
  • Know the borrower’s eligibility for a loan.
  • Calculate the appraised value of your home 
  • Compare the total loan amount with the home value.
  • To find the best loan options based on your equity or down payment.

A high LTV indicates high risk whereas if you have a low Loan to value ratio, it increases your probability of qualifying for the mortgage.

How to calculate LTV?

A loan-to-value ratio (LTV) is a calculation commonly used by lenders use to determine how much money they are willing to lend to a borrower. 

To determine LTV, simply divide the loan amount by the asset’s purchased value. 

For example, if someone borrows $100,000 to purchase a house worth $200,000, the LTV would be 50%. This means the lender is only willing to lend 50% of the purchase price, and the borrower would be responsible for the remaining 50%.

LTVs are a key part of a lender’s risk management strategy, protecting them against potential losses in the event of a default. By ensuring that the loan-to-value ratio is low, the lender reduces their exposure to a potential default and minimizes their risk.

A high LTV means the lender is taking on more risk and may require a higher interest rate or be less likely to approve the loan.

Loan-To-Value (LTV) Ratio Vs. Combined Loan-To-Value (CLTV) Ratio

The lender uses both entities when deciding whether or not the borrower is eligible for the loan. The LTV of a mortgage is the ratio of total property value to the remaining balance of the mortgage. 

Whereas the combined loan-to-value (CLTV) ratio is determined almost the same way as LTV but also includes all the loans taken on the property such as:

  • home equity loans, or
  • home equity lines of credit (HELOCs).

What effect does your loan-to-value ratio have on your mortgage?

One of the most crucial elements in obtaining a mortgage is the loan-to-value ratio or LTV. This ratio compares the amount of money borrowed to the appraised worth of the residence. This ratio is used by lenders to estimate the risk they are taking by lending a sizable amount to you.

The lower LTV reveals that the borrower has the potential to afford the property and pay off his debts on time. So, you are more likely to get mortgage approval. Nevertheless, it also implies that you will have to increase the size of your down payment when buying or refinancing a home or other real estate property. Not to forget, reduced LTV also helps lower your interest rate.

In contrast, a higher LTV will mean you will have to pay more in interest, and you may also be required to purchase mortgage insurance (PMI). It’s important to understand how your LTV affects your mortgage so you can make the best decision for your needs.

What are the implications of a low or high loan-to-value ratio?

A loan-to-value ratio can be high or low according to the market rates, and the borrower’s current credit score, income, savings, other loans, and many others. It strongly influences the type & size of the loan you’ll be offered by the lender.  A high loan-to-value ratio can leave a person more vulnerable to foreclosure if they are unable to make their monthly payments. Plus, it can help a person build equity in their home more quickly.

Some effective ways to Lower your loan-to-value ratio:

Here are some best possible ways that can help you lower the loan-to-value ratio. Check below:

  • The first, and most convenient way is to Make a larger down payment. We know it’s not an easy task but it will reduce the amount of money that you need to borrow, and will also reduce the amount of interest that you will have to pay. You can use a mortgage calculator to determine the size of the down payment you need to pay to get a lower LTV.
  • The second way to reduce your loan-to-value ratio is to Refinance your Loan. This will lower your monthly payments, and will also reduce the amount of interest that you will have to pay.
  • Another way is to buy an affordable home to reduce the size of your down payment, and hence the LTV ratio. Or offer the lower home price in exchange for the lower LTV.

Advantages of having a low loan-to-value ratio:

Having a low loan-to-value ratio is no less than a blessing especially when you are applying for a home mortgage. A borrower’s low LTV easily convinces the lender to approve your mortgage application, and lend you the money. Below are some major benefits of lower LTV:

  1. One of the biggest benefits is that you will be able to get a lower interest rate on your mortgage. This is because the lender is taking on less risk by lending to you.
  2. You will also be able to get a mortgage easily if you have less money saved up for a down payment. This is because the lender knows that you will have a lower loan-to-value ratio, which means that they will be able to recover more of their money if they have to foreclose on your home.
  3. It’ll help you build home equity.

How do lenders use the LTV Ratio?

Lenders Use The LTV Ratio

Lenders use Loan to value ratio to check your worth for buying or refinancing a real estate property. So they can make better and more informed decisions. LTV strongly influences your down payment, interest rates, and PMI ( private mortgage insurance). 

It can be low or high depending on your current financial status. It’s better to have a low LTV to easily qualify for the loan.

LTV Ratio Rules for different Loan types:

A variety of government-insured and private loan options are available such as VA, FHA, USDA, etc. The LTV ratio may vary depending on your lender and the type of mortgage you are applying for. Let’s find out, how?

LTV Ratio for FHA Loans

As compared to other loan types, FHA loans come with fewer restrictions and are insured by the Federal Housing Administration. That means, that borrowers with low to average income can easily get qualified for this loan. So, even if you have a high LTV ratio or a good credit score, you are eligible for FHA loans.

Typically, a 10% down payment is required plus the borrower has to bear the expenses of MIP (Mortgage insurance premium) installments each month for about 11 years.

LTV Ratio For USDA & VA Loans:

Borrowers with VA and USDA loans can have an LTV ratio of 100% or higher. The benefit is you don’t need to buy private mortgage insurance (PMI) insurance except for other loan expenses. 

FAQS about Loan to Value (LTV) ratio:

What’s a good LTV ratio?

At present, an LTV ratio of about 80% or lower is considered a good LTV as it boosts your chances of getting approved for the mortgage. The borrowers with high LTV have to pay PMI (private mortgage insurance) for about 11 years.

Which is better; a high or low LTV?

A borrower should have a low LTV (loan-to-value ratio). So, your lender can offer low-interest rates, and you don’t have to buy PMI.

Summing up:

So, now you know how important and essential is the Loan-to-value(LTV) ratio in a real estate transaction. It’s a major factor that influences your PMI, interest rate, and loan size. LTV is expressed in percentage and is used by lenders to know if the borrower is eligible for the loan or not. Plus it protects them from lending a high mortgage.

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