In financial terms, an LTV, or loan to value ratio, is a comparison between the size of a loan and the value of the asset being purchased. This can be calculated for any large purchase that requires a loan, including buying a home. It’s often used by lenders to determine the amount of risk when offering a mortgage. Homebuyers may hear this term during the buying process, so it’s important to understand what it means and why it’s important.
How the LTV Impacts the Mortgage
Lenders offer mortgage interest rates and other terms based on the amount of risk. A lender offering a mortgage will want to make sure the lender isn’t loaning too much. If the borrower defaults, the lender will want to make sure it can recover lost funds by selling the home. When the amount loaned is higher than the value of the home, full recovery may not be possible, so it’s a higher risk for the lender. The lower the LTV is, the more likely it is the lender will be willing to offer a mortgage.
How to Determine the LTV Percentage
A simple calculation is all that’s needed to determine the LTV for a mortgage. Take the total value of the home and subtract any funds that will already be paid, like the down payment. This is the total loan amount. Divide the total value of the home being purchased by the total loan amount. The result should be a number like .85. Move the decimal over two places to the right to get the percentage.
If a home is worth $500,000 and the borrower will be paying $100,000 in a down payment, the total loan amount will be $400,000. Then, $500,000 divided by $400,000 is .8. After moving the decimal, the LTV is 80%. This can be done with any down payments and home prices to compare LTVs for various loans to determine the risk to the lender.
LTVs Below 80%
Lenders generally prefer an LTV of 80% or below for a conventional mortgage. This is done by using at least 20% of the home’s value for the down payment. If a home is worth $300,000, the down payment will need to be at least $80,000 to get an LTV of 80% or lower. A larger down payment will make the LTV even lower, which will mean a much higher chance of being approved for a mortgage. It will also save you money by not needing to pay PMI.
LTVs Between 80% to 100%
Not everyone can put down a 20% or larger down payment for a home. Lenders will still offer mortgages when the LTV is between 80% and 100%, but there may be additional requirements. If a homebuyer puts down 3% on a $300,000 home, the LTV would be 97%. This is a much higher risk to the lender, so the lender may require added insurance, at a cost to the borrower. The insurance is intended to help cover any lost funds if the loan has defaulted and the seller cannot get the full amount owed by selling the home.
Do Buyers Need to Know the LTV?
It’s easy to calculate the LTV for a mortgage, so it’s something borrowers should do. Borrowers who know the LTV can have a better understanding of how it can impact the mortgage and what can be done to reduce the LTV or get better terms for their mortgage. Plus, knowing what the LTV is can provide borrowers with a better understanding of their mortgage and what they may need to know if they decide to refinance in the future.
Reducing the LTV
Some lenders do not mind a higher LTV, though they may add insurance requirements for ones over 80%. Still, borrowers who want to avoid that or who want to get the best deal possible on their mortgage may want to look into reducing the LTV. The way to do this is to increase the down payment provided or decrease the home’s cost. If the home is listed at $300,000, but the value of the home is only $275,000, it may be worth asking the sellers to reduce the cost. If the cost is reduced to the value, the borrower will have a lower LTV if they keep the same down payment. With the lower LTV, it may be possible to get a better deal or avoid added terms for the mortgage.
Lenders want to reduce their risk as much as possible when they offer a mortgage. The LTV is easy to calculate and can help lenders determine their amount of risk. For borrowers, determining the LTV provides the opportunity to see what the risk for lenders will be and to take steps to reduce the risk to get more favorable terms for the mortgage.