The combined loan-to-value (CLTV) ratio is the ratio of all secured property loans to the property's value. Lenders use the CLTV ratio to determine a prospective homebuyer's risk of default when more than one loan is used. In general, lenders are willing to lend at CLTV ratios of 80% and above to borrowers with high credit ratings.
To calculate the combined loan-to-value ratio, divide the aggregate principal balances of all loans by the property's purchase price or fair market value.
For example, suppose an individual purchased a home for $200,000; to secure the property, she provided a down payment of $50,000 and received two mortgages for $100,000 (primary) and $50,000 (secondary). Her combined loan to value ratio (CLTV) is 75%, (($100,000 + $50,000) / $200,000).
Loan-to-value (LTV) and CLTV are two of the most common ratios used during the mortgage underwriting process. Most lenders impose maximums on both values, above which the prospective borrower is not eligible for a loan. The LTV ratio considers only the primary mortgage balance. Therefore, in the above example, the LTV ratio is 50%, the result of dividing the primary mortgage balance of $100,000 by the home value of $200,000.
Most lenders impose LTV maximums of 80% because Fannie Mae and Freddie Mac do not purchase mortgages with higher LTV ratios. Borrowers with good credit profiles can circumvent this requirement but must pay private mortgage insurance (PMI) as long as their primary loan balance is greater than 80% of the home's value. PMI protects the lender from losses when a home's value falls below the loan balance.
Primary lenders tend to be more generous with CLTV requirements. Considering the example above, in the event of a foreclosure, the primary mortgage holder receives its money in full before the second mortgage holder receives anything. If the property value decreases to $125,000 before the borrower defaults, the primary lienholder receives the entire amount owed ($100,000), while the second lienholder only receives the remaining $25,000 despite being owed $50,000. The primary lienholder shoulders less risk in the case of declining property values and therefore can afford to lend at a higher CLTV.
Some homebuyers choose to lower their down payment by receiving multiple mortgages on a property, which results in a lower loan-to-value ratio for the primary mortgage. Also because of the lower LTV ratio, many homebuyers successfully avoid PMI. Whether it is better to obtain a second mortgage or incur the cost of PMI varies per individual.
Consequently, because the second mortgagor assumes more risk, the interest rate on a second mortgage is typically higher than the interest rate on a first mortgage. It is advisable that consumers consider the advantages and disadvantages of accepting multiple loans on one property. Exercising due diligence will help ensure that what is chosen is the best option for the given circumstances.