What Is the Loan-to-Value – LTV Ratio?
Loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more.
Additionally, a loan with a high LTV ratio may require the borrower to purchase mortgage insurance to offset the risk to the lender.
LTV Ratio Formula and Calculation
Home buyers can easily calculate the loan-to-value ratio on their home.
LTVratio=APVMAwhere:MA=Mortgage AmountAPV=Appraised Property Value
The process involves dividing the total mortgage loan amount into the total purchase price of the home. For instance, a home with a purchase price of $200,000 and a total mortgage loan for $180,000 results in a loan-to-value ratio of 90%. Conventional mortgage lenders often provide better loan terms to borrowers who have loan-to-value ratios no higher than 80%.
LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage. For example, if you buy a home appraised at $100,000 for its appraised value and make a $10,000 down payment, you will borrow $90,000 resulting in an LTV ratio of 90% (90,000 / 100,000).
- LTV is often used in mortgage lending to determine the amount necessary to put in a down-payment and whether a lender will extend credit to a borrower.
- Most lenders offer mortgage and home-equity applicants the lowest possible interest rate when the loan-to-value ratio is at or below 80%.
- Fannie Mae’s HomeReady and Freddie Mac’s Home Possible mortgage programs for low-income borrowers allow an LTV ratio of 97% (3% down payment) but require mortgage insurance until the ratio falls to 80%.
LTV and Loan Underwriting
The loan-to-value ratio is a critical component of mortgage underwriting, whether it be for the purpose of buying a home, refinancing a current mortgage into a new loan or borrowing against accumulated equity within a property.
Lenders assess the LTV ratio to determine the level of exposure to risk they take on when underwriting a mortgage. When borrowers request a loan for an amount that is at or near the appraised value and therefore a higher loan-to-value ratio, lenders perceive that there is a greater chance of the loan going into default because there is little to no equity built up within the property. Should foreclosure take place, the lender may find it difficult to sell the home for enough to cover the outstanding mortgage balance and make a profit from the transaction.
Factors Impacting the LTV Ratio
The main factors that impact LTV ratio are down payment, sales (contract) price, and appraised value. To achieve the lowest (and best) LTV ratio, raise the down payment and try to lower the sales price. Using the example above, suppose you buy a home that appraises for $100,000 but the owner is willing to sell for $90,000. If you make the same $10,000 down payment, your loan is only $80,000 resulting in an LTV ratio of 80% (80,000 / 100,000). If you increase your down payment to $15,000 your mortgage loan is now $75,000 making your LTV ratio 75% (75,000 / 100,000).
All of this is important because the lower the LTV ratio, the greater the chance the loan will be approved, the lower the interest rate is likely to be and the less likely you will be required to purchase private mortgage insurance (PMI).
LTV Ratio and Interest Rates
While the loan-to-value ratio is not the only determining factor in securing a mortgage, home-equity loan or line of credit, it does play a substantial role in how much borrowing costs the homeowner. In fact, a high LTV ratio can prevent you from qualifying for a loan or refinance option in the first place.
Most lenders offer mortgage and home-equity applicants the lowest possible interest rate when the loan-to-value ratio is at or below 80%. A higher LTV ratio does not exclude borrowers from being approved for a mortgage, although the total cost of the loan rises as the LTV ratio increases. A borrower with an LTV ratio of 95%, for instance, may be approved, but the interest rate may be up to a full percentage point higher than for a borrower with an LTV ratio of 75%.
In addition, if the LTV ratio is higher than 80% you will likely have to purchase private mortgage insurance (PMI), which can add anywhere from 0.5% to 1% of the entire loan amount on an annual basis. PMI of 1% on a $100,000 loan, for example, would add $1,000 to the amount paid per year or $83.33 per month. PMI payments continue until the LTV ratio is 80% or lower. The LTV ratio will decrease as you pay down your loan and as the value of your home increases over time.
Requiring an 80% (or lower) LTV ratio to avoid PMI is not law but it is the practice of nearly all lenders. Exceptions are sometimes made for borrowers with high income, lower debt or other factors like a large investment portfolio.
The maximum loan-to-value ratio is the largest allowable ratio of a loan's size to the dollar value of the property. The higher the loan-to-value ratio, the bigger the portion of the purchase price that was financed. Since the home acts as collateral for the loan, the loan-to-value ratio is a measure of risk used by lenders. Different loan programs are viewed to have different risk factors, and thus have different maximum loan-to-value ratios.
Loan Types and LTV Ratio
Certain loan types have special rules when it comes to the LTV ratio.
FHA loans, which allow an initial LTV ratio of up to 96.5%, require a mortgage insurance premium (MIP) that lasts for as long as you have that loan no matter how low the LTV ratio eventually goes. Most people refinance to a conventional loan once the LTV ratio reaches 80% to eliminate the MIP.
VA and USDA Loans
VA and USDA loans – available to current and former military or those in rural areas, respectively – do not require private mortgage insurance even though the LTV ratio can be as high as 100%. However, both VA and USDA loans do have additional fees.
Fannie Mae and Freddie Mac
Fannie Mae’s HomeReady and Freddie Mac’s Home Possible mortgage programs for low-income borrowers allow an LTV ratio of 97% (3% down payment) but require mortgage insurance until the ratio falls to 80%.
Streamline refinance options, which waive appraisal requirements (meaning the home’s LTV ratio doesn’t affect the loan), exist for FHA, VA and USDA loans. For those with an LTV ratio over 100% – also known as being “underwater” or “upside down” – Fannie Mae’s High Loan-to-Value Refinance Option and Freddie Mac’s Enhanced Relief Refinance, which are designed to replace the HARP Refinance Program that expires Dec. 31, 2018, are available.
Ranking the Loan-to-Value Ratio
An LTV ratio of 80% or lower is considered good for most mortgage loan scenarios. An LTV ratio of 80% provides the best chance of being approved, the best interest rate and the greatest likelihood you will not be required to purchase mortgage insurance. As noted above, however, VA and USDA loans allow for a higher LTV ratio (up to 100%) and still avoid costly private mortgage insurance, though other fees do apply.
For most refinance options, unless you are applying for a cash-out refinance, LTV ratio doesn’t matter, so there is no such thing as “good” or “bad.” If you apply for a cash-out refinance, an LTV ratio of 90% or less is considered good.
LTV vs. Combined LTV – CLTV
While the LTV ratio looks at the impact of a single mortgage loan when purchasing a property, 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 - for instance if they will have two or more mortgages, or a mortgage plus a home equity loan or line of credit (HELOC). In general, lenders are willing to lend at CLTV ratios of 80% and above to borrowers with high credit ratings.
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. 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.
Limitations of LTV
The main drawback of loan-to-value is that it only includes the primary mortgage that a homeowner owes, and does not include other obligations such as a second mortgage or home equity loan. Therefore, combined loan-to-value (CLTV) is a more inclusive measure of a borrower's ability to repay a home loan.