One of many factors involved in the review of a mortgage application is the loan-to-value (LTV) ratio. Lenders will look at this ratio as one of the determinants for how much money they are willing to lend you, or if you are eligible for a mortgage from their organization at all.
This ratio comes into play whether you are buying a home or refinancing your current mortgage. In this article, we will explain what LTV is, why it matters, and what you can do about yours.
What is the Loan-to-Value (LTV) ratio?
Your loan-to-value ratio is typically expressed as a percentage. It measures the size of the loan against either the purchase price or appraised value of the home (whichever is lower). Lenders use LTV as a part of their risk assessment for each borrower.
Basically, the higher that ratio is, the more money a lender is putting toward the transaction, thus increasing their risk. If you were to default on your mortgage, a lender would likely lose more money on a loan with a 90% LTV than they would one with an 80% LTV. Note that loan-to-value ratios are affected by your down payment. A larger down payment decreases the LTV ratio.
Calculating LTV
You can calculate the LTV ratio fairly easily. Divide the loan amount by the lower of the purchase price or appraisal value and then multiply that number by 100 (this will give you the percentage). So, let’s say you were buying a home worth $500,000, and you put down a 20% down payment of $100,000. Then, your total loan amount needed to pay the purchase price of the home would be $400,000. Divide 400,000 by 500,000, and the LTV ratio for that mortgage would be 80%.
What is combined loan-to-value (CLTV)?
Combined loan-to-value (CLTV) works similarly to LTV, but it takes into account all loan balances on your home. So, if you had taken out a home equity loan, a home equity line of credit, or any other loan secured by your home, that would impact your CLTV.
Why does LTV matter for a mortgage?
As stated above, lenders use this ratio to help determine their risk for each mortgage. They typically have maximum LTV ratios for each type of loan, so if a borrower cannot meet that, it can result in a rejected mortgage application.
A lower percentage for the LTV typically reflects less risk for the lender, as it indicates more early equity in the property from the buyer. Lowering the LTV ratio can be beneficial for borrowers, too. When paired with other positive personal financial factors, such as a high credit score, a lower LTV can potentially lower your interest rate.
Additionally, for certain loan types, you may be required to pay for private mortgage insurance if you can’t meet a certain LTV threshold. Private mortgage insurance (PMI) adds another layer of protection for lenders against possible defaults or foreclosures.
Federal Housing Administration (FHA) loans
FHA loans typically have higher LTV maximums than conventional loan types. For The Federal Savings Bank, that LTV maximum is 96.5%. However, if you have that LTV ratio for your FHA loan, you may want to prepare to pay Annual Mortgage Insurance Premiums (MIP). MIP is usually paid monthly, despite the name, and its duration varies based on the LTV and base loan amount.
Veterans Affairs (VA) and United States Department of Agriculture (USDA) loans
Many know that VA and USDA loans generally do not require a down payment. As such, The Federal Savings Bank has LTV ratio maximums of 101.01% (100% plus the guarantee fee) for a USDA loan and 100% for conforming VA loans (90% LTV for manufactured homes). Unlike FHA loans, eligible VA or USDA loan borrowers could potentially qualify for these loans with 100% LTV ratios and not have to pay for private mortgage insurance.
LTV for Refinancing
If you’re looking to refinance, your LTV is then calculated using the remaining principal balance on your mortgage and the current value of your property. The good news for many homeowners is that you can lower your LTV ratio by making your regular mortgage payments. Additionally, if your home has increased in value since you bought it, that can potentially lower your LTV ratio. These inputs may possibly work in your favor when refinancing.
How can I lower my LTV?
Lowering the LTV ratio on a mortgage, in the simplest terms, can be done in two main ways:
- Increase your down payment. As your down payment goes up, your LTV should go down. It may be beneficial to either pay more now or save up until you have a larger down payment available.
- Find a less expensive house. If you can’t increase your down payment, it may be smart to try to decrease the total purchase price. Generally, that means finding a cheaper home. A $30,000 down payment on a $300,000 home will give you a lower LTV ratio than the same down payment on a $400,000 home.
Final Thoughts
So many factors are at play when lenders assess your mortgage application. Loan-to-value ratios are just one of many, though they are worth understanding. A lower LTV ratio, when paired with other positive personal financial factors, has the potential to yield better mortgage terms for the borrower. As you go through your home buying process, think about what you can do to impact that ratio and what costs, such as private mortgage insurance, are acceptable to you.
This information is intended for educational purposes only. Products and interest rates subject to change without notice. Loan products are subject to credit approval and include terms and conditions, fees and other costs. Terms and conditions may apply. Property insurance is required on all loans secured by property. VA loan products are subject to VA eligibility requirements. Adjustable Rate Mortgage (ARM) interest rates and monthly payment are subject to adjustment. Upon submission of a full application, a mortgage banker will review and provide you with the terms, conditions, disclosures, and additional details on the interest rates that apply to your individual situation.
