When you're getting approved for a mortgage, you're likely to come across the acronym LTV, which refers to the Loan-to-Value ratio.
In this blog, we'll cover what the Loan-to-Value ratio means, why it matters, and how it affects your mortgage rate.
The Loan-to-Value is the ratio of your mortgage and your property’s appraised value. The appraised value is collateral.
For example: The house you want to buy is $200,000. You put $40,000 as the down payment and use a loan for the remaining balance. Your beginning LTV is 80%. As you pay off your mortgage, your LTV becomes lower and your equity goes higher.
LTV measures risk.
The more a borrower puts their own skin in the transaction, the lender takes on less risk. Here’s a quick example:
- $450,000 home purchase.
- 20% down payment by the borrower.
- The borrower is putting $90,000 into the purchase ($450k x 20%).
However, if the borrower only puts 5% down, which is $22,500 ($450k x 5%) on a $450,000 purchase, the lender is on the hook for more risk if the borrower defaults.
The lender takes on less risk when the borrow puts more money into the transaction as the lender has more collateral.
How does LTV affect your loan?
Most lenders require your LTV to at or lower than 80%. The higher your LTV is, the higher the perceived risk is from the viewpoint of the lender. This has serious implications in your loan application:
- The lender may give you higher interest rates.
- The lender will require private mortgage insurance (PMI) if you put less than 20% down.
You can compute your LTV here.
Credit cards are not backed by an asset.
These companies trust you are going to pay back your charges every month or at least the minimum payment. If the credit card customer defaults, the credit card company has to go after the customer to work out a payment plan or deal with a possible bankruptcy. In short, the credit card company most likely will eat the loss.
Home loans are secured by collateral.
Mortgage collateral is the value of your home. Simple economics believes a borrower will take more interest in keeping their home by making mortgage payments if they have put more money into the purchase such as 20%.
On the other hand, if a borrower only puts 3.5% for a down payment and walks away, they have much less to lose. If a bank has to take back a home, they would rather take it over with a higher equity stake so they can hopefully get out of this situation with minimum loss. The bank still has to clean the home, fix it up, and pay fees to realtors and title companies.
Banks are not looking to take over properties they have made loans on.
Are there loan programs for borrowers with high LTV?
There are 100% LTV programs, which means the borrower pays no down payment.
Examples of 100% LTV programs (no-money-down payment):
Example of 96.5% LTV programs (3.5% down payment):
- FHA borrower pays 3.5% of purchase price (this can come from a gift).
Example of 97% LTV programs (3% down payment):
- Conventional loan borrower is responsible for 3% of purchase price.
What determines the appraised value?
The appraisal - plain and simple.
Not all loan transactions require an on-site appraisal. The appraiser is a third party and someone who is certified to determine the value and writes a report, which is called an appraisal. To learn more, read our article, Property Inspection Waiver: Say goodbye to appraisals, to learn more.
Loan-to-Value is an important metric.
Lenders use the LTV ratio to underwrite your loan. Borrowers with lower LTV are offered lower rates due to less risk to the lender. These types of borrowers have more equity in their homes and have more to lose financially by defaulting on their home.
However, borrowers with higher LTV should not be discouraged. There are loan programs available to help with the dream of home ownership. For more information on live pricing using your loan scenario, read about our instant loan approval.