What Is a Maximum Loan-to-Value Ratio?
A loan-to-value ratio (LTV) compares the amount of a loan to the value of the property it is being used to purchase. A maximum loan-to-value ratio is the highest LTV a lender is willing to accept. In mortgage lending, for example, the higher the loan-to-value ratio, the larger the percentage of a home's purchase price that is being financed through borrowing. Since the home serves as collateral for the loan, lenders use the loan-to-value ratio as a measure of the risk they are taking on.
- A loan-to-value ratio compares the amount of a loan, such as a mortgage, to the value of the property it is being used to purchase.
- Lenders use the loan-to-value ratio as a measure of the risk involved in a particular loan.
- The maximum loan-to-value ratio is the largest percentage a lender will accept.
- The larger the down payment a borrower makes, the lower the loan-to-value ratio.
- Down payment requirements vary by lender and loan program to loan program.
How Maximum Loan-to-Value Ratio Works
Lenders set maximum loan-to-value ratios to ensure that they can get their money back (or at least a good chunk of it) if the borrower defaults on the loan and the lender has to seize and sell their collateral. The lower the loan-to-value ratio is, the less risk the lender is assuming. Maximum loan-to-value ratios are used with many types of loans, particularly with home mortgages and auto loans.
Some home loan programs that are designed specifically for low- to moderate-income and first-time home buyers allow for relatively high maximum loan-to-value ratios. Many of these loans, which are offered through private lenders, such as banks, are sponsored and subsidized by state and local governments, the Federal Housing Administration (FHA), and the Veterans Administration, among others. Their guarantees reduce the lender's financial risk.
The maximum loan-to-value ratio a lender will accept can also vary from borrower to borrower. Lenders make that decision based on a number of factors, such as the borrower's credit profile and how easy it would be to sell their collateral in the event of a default.
Upfront fees on Fannie Mae and Freddie Mac home loans changed in May 2023. Fees were increased for homebuyers with higher credit scores, such as 740 or higher, while they were decreased for homebuyers with lower credit scores, such as those below 640. Another change: Your down payment will influence what your fee is. The higher your down payment, the lower your fees, though it will still depend on your credit score. Fannie Mae provides the Loan-Level Price Adjustments on its website.
Calculating Maximum Loan-to-Value Ratio
Lenders rarely offer loans that will cover 100% of the purchase price of a home or other asset. Instead, the borrower is required to make a cash down payment. In the case of some government-subsidized mortgages, that can be as low as 3%. (Two exceptions are VA loans and USDA loans, which are partially subsidized by the Veterans Administration and U.S. Department of Agriculture, respectively; they allow down payments as low as 0% in certain cases.) Other lenders require higher down payments, such as 10%, 15%, or 20%. A 20% down payment was once the common standard.
Calculating a loan-to-value ratio is straightforward. You divide the amount of the loan by the purchase price of the asset.
Suppose, for example, that you want to buy a $200,000 home and are planning to make a down payment of 20%, or $40,000. That means you'll need to borrow the remaining $160,000. In this case, the loan-to-value ratio would be 0.80 ($160,000 divided by $200,000), or 80%.
The typical down payment for first-time home buyers was 7% in 2021, while repeat buyers typically put down 17%, according to the National Association of Realtors.
On the other hand, if you were able to buy that same home with a 3% down payment, such as through a Fannie Mae loan, your down payment would be $6,000, and your mortgage would cover the remaining $194,000. Here your loan-to-value ratio would be 0.97 ($194,000 divided by $200,000), or 97%.
Notably, if you make a down payment of less than 20% on a conventional mortgage, the lender will probably require you to purchase private mortgage insurance, or PMI. The purpose of PMI is to give the lender additional protection in the event of a default. If the equity you have in your home rises to a point where it equals or exceeds 20% of the original purchase price, you can ask the lender to cancel the PMI.
The cost of PMI varies according to the loan-to-value ratio of the mortgage, the creditworthiness of the borrower, and other factors. It can also vary from one insurer to another even under identical circumstances. As a general rule, the Federal Home Loan Mortgage Corporation (Freddie Mac) says that, "You can expect to pay between $30 and $150 per month for every $100,000 you borrow."
FHA and USDA loans can also have mortgage insurance requirements.
What Is Fannie Mae?
Fannie Mae, formally known as the Federal National Mortgage Association, is a government-sponsored enterprise that doesn't lend money itself, but instead purchases mortgages from lenders, which frees up more money for them to issue new mortgages. Fannie Mae then bundles those mortgages into mortgage-backed securities, which it sells to investors.
What Is the Maximum Loan-to-Value Ratio on a Fannie Mae Loan?
The minimum down payment on a Fannie Mae loan can be as low as 3%, which translates into a maximum loan-to-value ratio of 97%.
What Is Fredde Mac?
Freddie Mac is a government-sponsored enterprise similar to Fannie Mae. The key difference between the two is that Freddie Mac tends to buy loans from smaller banks. As with Fannie Mae, the down payment on a Freddie Mac loan can be as low as 3%.
What Is the Maximum Loan-to-Value Ratio on an FHA Loan?
The minimum down payment on an FHA loan is 3.5%, for a maximum loan-to-value ratio of 96.5%.
What Is a Conventional Mortgage?
A conventional mortgage is one that is offered by private lenders and not government-subsidized. Conventional mortgages can be either conforming (meaning that they conform to Fannie Mae and Freddie Mac requirements, making them eligible for repurchase) or nonconforming, such as jumbo loans that exceed Fannie Mae and Freddie Mac limits.
The Bottom Line
The maximum loan-to-value ratio on a mortgage can vary widely from lender to lender and program to program. If you're shopping for a mortgage it's smart to compare loans based on how large a down payment you can afford, what their interest rates and fees will mean in terms of your monthly payments, and whether you'll have the additional cost of PMI.