If you are looking to purchase residential or commercial real estate, you need to know your loan-to-value (LTV) ratio. LTV stands for loan-to-value ratio. Lenders use the loan-to-value ratio to calculate how much risk they are assuming when lending you money for a mortgage.
Loan-to-value ratio affects your interest rate, the amount owed, and your ability to qualify for a home loan. Below, we’ll walk you through what the loan-to-value ratio is, why it matters, and how to calculate it.
What Is LTV Ratio?
The loan-to-value ratio measures the amount of money you need to borrow against the market value of the asset.
A lower LTV shows that there is less risk for the lender to provide the funds to the borrower. A higher LTV indicates more risk for the lender because there is less money upfront:
- A low LTV ratio would be anything equal to or less than 80%
- A high LTV would be 95% or greater.
Any type of lender can evaluate risk by calculating the loan-to-value ratio, but it’s most commonly used for real estate and mortgage loans. Some lenders require a certain LTV percentage to qualify for a loan.
What Does a Low Loan to Value Ratio Indicate?
A low loan-to-value ratio indicates that a relatively small percentage of the value of an asset is financed by a loan or mortgage. In other words, the borrower has a larger equity stake in the asset compared to the amount borrowed.
- LTV Ratio = (Loan Amount / Property Value) * 100
- LTV Ratio = ($150,000 / $200,000) * 100
- LTV Ratio = 75%
In this scenario, the LTV ratio is 75%, indicating that the borrower has provided a 25% down payment or equity in the property.
A low LTV ratio generally suggests several things:
- Lower Risk for Lenders: A lower LTV ratio is often seen as less risky for lenders because there is a larger buffer of equity in the asset. If the borrower defaults and the lender needs to sell the property to recover the loan, there’s a greater likelihood of recovering the loan amount.
- Potential for Better Loan Terms: Borrowers with low LTV ratios may be eligible for more favorable loan terms, including lower interest rates and reduced mortgage insurance requirements.
- Stability for Borrowers: A low LTV ratio can indicate that the borrower is financially stable and has a stronger ability to handle mortgage payments.
- Less Exposure to Market Volatility: A higher equity stake in the property can provide some protection against property value fluctuations and potential market downturns.
- Higher Flexibility: Borrowers with a low LTV ratio may have more flexibility in refinancing or selling the property in the future.
What’s the Difference Between LTV and CLTV?
LTV (Loan-to-Value) and CLTV (Combined Loan-to-Value) are both financial ratios used in the context of real estate and lending, particularly in mortgage financing. They help lenders assess the risk associated with providing loans for real estate transactions.
However, they have distinct meanings and applications:
- Loan-to-Value (LTV): LTV is a ratio that compares the loan amount to the appraised value or purchase price of a property. It is calculated as: LTV Ratio = (Loan Amount / Property Value) * 100. LTV represents the percentage of the property’s value that is financed by a single loan.
- Combined Loan-to-Value (CLTV): CLTV is a ratio that considers the total amount of loans secured by a property in relation to its appraised value or purchase price. It takes into account multiple loans, such as a primary mortgage and a second mortgage or home equity loan. CLTV is calculated as: CLTV Ratio = (Sum of Loan Amounts / Property Value) * 100.
How to Calculate Your Loan-to-Value Ratio
Let’s calculate your LTV to find out how much risk the lender will take on if they work with you.
Calculating your loan-to-value ratio is easy. All you need is to know how much money you still owe on your loan, how much you have paid off, and some math skills.
To calculate your LTV ratio, divide the amount of the loan by the appraised value of the asset securing the loan.
Loan amount / Appraised value of the asset = Loan-to-Value
The amount of money you put down is what alters your loan-to-value ratio. The greater the down payment you put down the lower your LTV ratio will be. And vice versa; the lower the down payment, the higher your LTV ratio will be.
For example, let’s say you’re seeking out a loan of $200,000 for a new home. You want to avoid paying PMI so you put 20% down, which is $40,000. Therefore, you only need to borrow $160,000.
To calculate your LTV ratio you would divide the amount borrowed: $160,000 by the appraised value of the asset: $200,000. This would give you a LTV ratio of 80%.
$160,000 / $200,000 = 80%.
This is a strong LTV ratio. Lenders like to see LTV ratios of 80% or less. If you can achieve this ratio, you will have a much easier time getting a loan.
Realistically, most homebuyers cannot afford a $40,000 down payment on a home. Many potential property owners eat the cost of PMI and only put down 5 to 10%. Let’s say you put a minimum down payment of 5% on a $200,000 loan for a total of $10,000. Your LTV ratio would be 95%.
$190,000 / $200,000 = 95%
Remember that lenders want to see a lower LTV ratio because it’s less risky. The more risk the lender endures the more interest they will tack on to your loan to help lower that risk. Although this LTV ratio is fairly high, you can still qualify for a mortgage with a 95% ratio.
How Your Loan-to-Value Ratio Affects Your Loan Options
As we talked about earlier, lenders use the loan-to-value ratio to access risk. Depending on what your LTV ratio is, you may not qualify for different types of loans or interest rates. Our experts highlighted the 3 most popular home loans to show you how your loan-to-value ratio affects your loan options.
Conventional Loans
Conventional loans are loans that are backed by private mortgage lenders. They follow the lending guidelines set by Fannie Mae and Freddie Mac. Borrowers can obtain a conventional loan with a LTV of 97% or higher. If you want to avoid paying PMI (private mortgage insurance) you will need to have a LTV of 80% or lower.
FHA Loans
FHA loans are mortgage loans backed by the Federal Housing Administration. These home loans are more flexible than conventional loans, requiring a lower minimum down payment and lower credit scores. You can qualify for an FHA loan with an LTV as high at 96.5%, that’s only 3.5% down!
VA Loans
VA loans are by far the most borrower-friendly mortgage loans you can get. However, not everyone will qualify for a VA loan. To qualify you need to be a veteran. VA loans don’t require a down payment allowing borrowers to get approved for a loan with an LTV ratio of 100% (borrowing 100% of the asset’s value).
How to Lower Your Loan-to-Value Ratio
There are a few different ways borrowers can lower their LTV ratio—however, there are 2 that are much more popular than alternative methods.
The 2 most common ways to lower your LTV ratio are:
- Putting down a larger down payment
- Buying a lower-priced home
Both ways involve reducing the amount of money you need to borrow.
Putting down a larger down payment lowers your LTV ratio by reducing the amount of money you need to borrow. Paying more upfront can eliminate the need for private mortgage insurance (PMI) and even lower the interest rate over the life of the loan.
Buying a lower-priced home lowers your LTV ratio by reducing the price of the asset’s value. If you find a more affordable home, you will be able to pay a larger percentage for a down payment which in turn, lowers your LTV.
Why Your Loan-to-Value Ratio Is Important
LTV ratios are important for both borrowers and lenders. Lenders use them as a key metric to measure the risk they are taking on by lending you money. LTV is important for buyers because, without a good LTV ratio, you may not qualify or get approved for a mortgage loan.
If you are thinking of buying a property you should calculate your LTV to get an idea of what loans you will qualify for and what your payments will be.
There are LTV calculators out there if you aren’t confident in your math skills, but usually your cell phone’s calculator will be able to get the job done.
If you want more insights about loan-to-value ratios and how to lower your percentage, we can help! At Yieldi, we specialize in getting you the funds you need to buy a home or investment property.
Get in touch with our team today for a free consultation!