Loan-to-Value is defined as the amount of a given loan compared to the total value of an asset. Although the term is used most frequently with mortgages, Loan-to-Value can be applied to any form of borrowing and lending.
Sometimes lenders set limits on the Maximum Loan-to-Value based on their “risk tolerance” and other factors. For example, your lender may allow you to borrow up to 80% of the value of your property if you are a first-time buyer but only 70% if you already own another property. The basic principle behind these limits is a higher risk in lending money to someone who already has debt.
Loan-to-Value is the relationship between the size of your loan and the value or worth of your property. The less you owe, compared to the actual value of what you own, the lower your Loan-to-Value.
It is important because the lower your Loan-to-Value, the more you can borrow. You should also consider how low your Loan-to-Value is when buying a property because it could affect your ability to get a mortgage or change how much you have to pay for homeowners insurance.
You can use Loan-to-Value when buying a house if you are unsure how much of your own money to put down. If you have 20% for the down payment, the Loan-to-Value would be 80%. It means that you can borrow up to 80% of what your home is worth, which is often the maximum most mortgage lenders will allow.
Loan-to-Value works as a basis for the payment calculation to determine how much you will pay monthly. The LTV is often used as a tool for lenders to decide whether or not an individual is eligible for the loan program. For example, if your Loan-to-Value ratio is too high, you may have trouble getting approved for that loan.
What is Loan-to-Value (LTV) Ratio?
Loan-to-Value Ratio is the percentage that reflects how much financing you are borrowing concerning your home’s value. The LTV ratio will be calculated during the underwriting process, calculating how much you will be allowed to borrow.
There are two types of Loan-to-Value Ratio – one for Conventional loans and another for FHA loans. The Conventional Loan LTV ratio is based on the appraised value, while the FHA loan ratio is based on the purchase price plus certain closing costs.
Loan-to-Value aims to determine how much money a borrower is putting in when buying the home. The less the down payment, the higher your Loan-to-Value Ratio will be. The percentage you will have to put up for collateral in case of default on a loan will play a significant role in determining this ratio.
Loan-to-Value can be the basis for calculating your monthly repayments. If you apply for a mortgage loan, Loan-to-Value will be calculated using an appraisal or purchase price and closing costs.
Lenders use Loan-to-Value as a tool when deciding whether or not to approve an individual for a loan. If you have a high Loan-to-Value, you may be refused if your lender considers this level of debt risky. Borrowers use Loan-to-Value to determine how much they can borrow, and lenders use it to determine the maximum loan amount.
How Loan-to-Value is Used by Lenders
Lenders use Loan-to-Value Ratio to determine how much money you are applying for versus how much your home is worth. If the ratio is high, then it means that you are putting less of your own money into buying the house, which can affect whether or not you will be approved for a mortgage loan or home equity loan.
You should make sure not to borrow more than 80% of your home’s appraised value if it is a Conventional loan and more than 96.5% for an FHA loan. It means that you can carry a high Loan-to-Value ratio, but only up to certain limits.
What are the Disadvantages of the Loan-to-Value?
There are a few disadvantages to the Loan-to-Value ratio. The primary disadvantage is that it can determine whether or not you are eligible for a loan in the first place. If your lender thinks too much risk is involved, they may reject your application.
Another drawback is that it doesn’t include a second mortgage or home equity loan in its calculations, which is a part of a borrower’s obligations. Loan-to-Value only consists of the primary mortgage that you are applying for.
How to Calculate Loan-to-Value?
When applying for a loan, the lender will calculate your Loan-to-Value ratio using either an appraisal or purchase price and mortgage amount. If there is no stated value on the home’s certificate of title, then the lender has the right to estimate what it is worth.
You need to divide the mortgage amount by the property value to determine your Loan-to-Value ratio. LTV ratio is expressed as a percentage.
It is the formula for calculating the Loan-to-Value ratio:
LTV = MA / APV
MA = Mortgage Amount
APV = Appraised Property Value
The mortgage amount is the amount you are borrowing on the mortgage loan. The appraised property value is the value that the home is judged to be worth.
For example:
$200,000.00 is the mortgage amount
$250,000.00 is the property value
LTV = MA / APV
LTV = $200,000.00 / $250,000.00
The LTV ratio in this example is 80%. It means that only 20% of the price has been paid out of the buyer’s pocket.
What is a Good Loan-to-Value Ratio?
Lenders usually suggest that an excellent Loan-to-Value ratio is 80% or lower. It means that you are putting in enough of your own money to buy the home while still being able to borrow money through a mortgage loan.
You need to determine what an excellent Loan-to-Value ratio would be based on how much cash you have readily available, your credit score and how much you want to borrow. The higher your Loan-to-Value ratio is, the less money you will have available for other financial obligations like paying back credit cards or loans.
Some factors may affect the Loan-to-Value ratio, such as your credit score or whether or not you are self-employed. Lenders take individual circumstances into account when deciding whether or not to approve an application for a loan.
How to Lower the Loan-to-Value Ratio
You may be able to lower your Loan-to-Value ratio by taking out a home equity loan or second mortgage, which is an additional amount of money beyond the primary mortgage. It will make up some of what you lack in funds and lower your Loan-to-Value ratio.
This decision should only be made if you have enough equity in your home. Otherwise, you could risk losing your property if you cannot pay back the additional debt that is owed.
Another way to improve the LTV ratio is to make regular payments on your mortgage. If you are in the beginning stages of your mortgage loan, this can decrease your Loan-to-Value ratio.
Increase your property value by making home improvements. Lenders consider the property value when calculating your Loan-to-Value ratio. It means that if you increase the value of your home, it will be lower than the amount you are borrowing.
What is the Example of the Loan-to-Value?
An example of the Loan-to-Value ratio is a property that has been appraised at $200,000.00 and has a mortgage amount of $175,000.00.
The LTV ratio would be calculated as follows:
LTV = MA / APV
LTV = $175,000.00 / $200,000.00
LTV = .85 or 85%
As you can see, the Loan-to-Value ratio for this example is 85%. The lender would be comfortable approving a mortgage loan for this borrower because they minimize their risk by putting in 15% of the price while only borrowing the remainder through a mortgage.
What is the Difference between Loan-to-Value and Combined Loan-to-Value?
Combined Loan-to-Value is the total of all mortgages against a property. It includes your primary mortgage and any secondary loans that are owed. In contrast, Loan-to-Value is just the primary mortgage. They are both similar in terms of what they mean for a property.
The combined Loan-to-Value is a more accurate figure of the actual value of the home if everything was paid off and there were no loans to be had on it. If you want to avoid paying taxes, this is how much your property would be worth without considering any mortgages or secondary loans.
However, Loan-to-Value is different from combined Loan-to-Value because the Loan-to-Value takes into account just the primary mortgage and doesn’t consider any other loans that may be owed on a property.
Both figures are important when considering how much home you can afford. The amount of money you can borrow against your primary mortgage will be based on both Loan-to-Value ratios. While the ratio of the two will be used to determine what your mortgage payment would be.
What are the other Real Estate Terms similar to Loan-to-Value?
You may also be interested in learning about the following real estate terms related to Loan-to-Value such as:
- Home Equity Loan: A second mortgage can be used for whatever the homeowner chooses. It is a second mortgage, and any money borrowed from it needs to be paid back. It can either provide cash for the homeowner or lower the Loan-to-Value ratio by adding money to the existing mortgage.
- Combined Loan-to-Value: The total of all mortgages against a property. It includes your primary mortgage as well as any secondary loans. Combined Loan-to-Value is a more accurate figure of the actual value of the home if everything was paid off and there were no loans to be had on it.
Primary Mortgage: A person’s first mortgage that they take out will therefore become their primary loan debt. It is what they are borrowing against the property, and any money they get from it also needs to be paid back.