What Is A Loan To Value Ratio?
Last Updated on March 31, 2021 by Ephraim Iyodo
The loan-to-value ratio (LTV) is an assessment of credit risk that financial institutions and other lenders consider before approving a mortgage.
Most lenders offer mortgage and home-equity applicants the lowest possible interest rate when the loan-to-value ratio is at or below 80%.
Measure Of The Loan To Value Ratio
Prospective home buyers can easily calculate the LTV ratio of a home. This is the formula:
LTV ratio =MA/PV
MA = mortgage amount
APV = property value
An LTV ratio is calculated by dividing the amount borrowed by the estimated value of the property, expressed as a percentage.
For example, if you buy a house that is estimated to be worth $100,000 and make a down payment of $10,000, you are borrowing $90,000. This results in an LTV ratio of 90% (i.e. 90,000 / 100,000).
Determining an LTV ratio is an important component of underwriting mortgages.
It can be used when purchasing 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 risk they are taking when underwriting a mortgage.
When borrowers apply for a loan for an amount that is at or near the appraised value (and therefore has a higher LTV ratio), lenders see a greater likelihood that the loan will go into default.
This is because very little equity is built up within the property. As a result, in the event of foreclosure, it may be difficult for the lender to sell the home to the point where the outstanding mortgage balance is covered and still make a profit on the transaction.
The main factors affecting LTV ratios are the amount of the down payment, the sales price and the appraised value of a property. The lowest LTV ratio is achieved with a higher down payment and a lower sales price.
Disadvantages of Loan-to-Value (LTV)
The main disadvantage of the information provided by an LTV is that it only includes the primary mortgage owed by a homeowner and does not include other obligations of the borrower, such as a second mortgage or home equity loan, in its calculations.
Therefore, the CLTV is a more comprehensive measure of a borrower’s ability to repay a home loan.