What Is the Combined Loan-to-Value (CLTV) Ratio?
The combined loan-to-value (CLTV) ratio is the ratio of all secured loans on a property to the value of a property. Lenders use the CLTV ratio to determine a prospective home buyer'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. The CLTV differs from the simple loan to value (LTV) ratio in that the LTV only includes the first or primary mortgage in its calculation.
The Formula for the Combined Loan-to-Value (CLTV) Ratio Is
How to Calculate the Combined Loan-to-Value (CLTV) Ratio
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. The CLTV ratio is thus determined by dividing the sum of the items listed below by the lesser of the property's sales price or the appraised value of the property.
- the original loan amount of the first mortgage
- the drawn portion (outstanding principal balance) of a home equity line of credit (HELOC)
- the unpaid principal balance of all closed-end subordinate financing, such as a second or third mortgage (With a closed-end loan, a borrower draws down all funds on day one and may not make any payment plan changes or access any paid-down principal once the loan is closed.)
What Does the Combined Loan-to-Value (CLTV) Ratio Tell You?
The combined loan to value (CLTV) ratio is a calculation used by mortgage and lending professionals to determine the total percentage of a homeowner's property that is encumbered by liens (debt obligations). Lenders use the CLTV ratio along with a handful of other calculations, such as the debt-to-income ratio and the standard loan to value (LTV) ratio, to assess the risk of extending a loan to a borrower.
Many economists attribute relaxed CLTV standards to the foreclosure crisis that plagued the United States during the late 2000s, among other factors. Beginning in the 1990s and especially during the early and mid-2000s, home buyers frequently took out second mortgages at the time of purchase in lieu of making down payments. Lenders eager not to lose these customers' business to competitors agreed to such terms despite the increased risk.
Prior to the real estate bubble that expanded from the late 1990s to the mid-2000s, the standard practice was for home buyers to make down payments totaling at least 20% of the purchase price. Most lenders kept customers within these parameters by capping LTV at 80%.
When the bubble began to heat up, many of these same companies took steps to allow customers to get around putting 20% down. Some lenders raised LTV caps or did away with them completely, offering mortgages with 5% down payments or less, while others kept LTV requirements in place but raised CLTV caps, often to 100%. This maneuver enabled customers to take out second mortgages to finance their 20% down payments.
The foreclosure spike beginning in 2008 underscored why CLTV is important. Having skin in the game, such as a $100,000 initial cash outlay for a $500,000 house, provides a homeowner with a powerful incentive to keep up his mortgage payments. If the bank forecloses, he not only loses his home but also the pile of cash he paid to close.
Requiring equity in the property also insulates lenders from a dip in real estate prices. If a property is valued at $500,000 and the total liens add up to $400,000, the property can lose up to 20% of its value without any lien holders receiving a short payment at a foreclosure auction.
- CLTV is similar to LTV but includes all mortgages or liens and not just the first mortgage.
- Lenders consider the CLTV ratio in determining whether a home buyer can afford to purchase a home.
- The real estate bubble of 2008-2009 underscored the relevance of keeping an eye on the CLTV ratio.
Example of How to Use the Combined Loan-to-Value (CLTV) Ratio
As an example, suppose an individual is purchasing 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 therefore 75%: (($100,000 + $50,000) / $200,000).
The Difference Between Loan-to-Value and Combined Loan-to-Value
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 lien-holder receives the entire amount owed ($100,000), while the second lien-holder only receives the remaining $25,000 despite being owed $50,000. The primary lien-holder shoulders less risk in the case of declining property values and therefore can afford to lend at a higher CLTV.
When Combined Loan-to-Value Matters
Some home buyers 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 home buyers successfully avoid private mortgage insurance (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.