What Does Loan-To-Value Ratio (LTV) Mean And How Does It Affect You?

If you’re new to the world of credit and borrowing, the number of acronyms can be overwhelming. Loan-to-value ratio, or LTV, is an important metric to understand if you’re planning on taking out a secured loan. Fortunately, the LTV ratio is fairly easy to understand: It’s based on the size of your loan relative to the cost of your purchase.

What Is Loan-To-Value Ratio (LTV)?

Loan-to-value is a ratio that compares the loan amount to the value of the asset purchased with that loan. It’s common for LTV to be associated with mortgage loans, but it can also be used for other home or vehicle loans. Lenders look at the LTV of a proposed loan when determining whether the loan will be approved and when determining interest rates.

How Do Mortgage Lenders Use LTV?

LTV helps lenders assess how much risk they’re taking on when they lend money to a borrower. They’ll look at other metrics, too – like the borrower’s credit history and debt-to-income ratio – but LTV is a metric that ultimately tells lenders how much they’ll be on the hook for if the borrower defaults on the loan.

The higher your LTV, the more risk the lender takes on, and the more interest you’re likely to pay to borrow money.

How Is LTV Ratio Calculated?

To calculate a loan’s LTV you’ll need to know your loan amount, or the total amount you’ll be borrowing and how much money you can afford as a down payment.

For example, if you’re purchasing a home that’s listed for $200,000 and making a $40,000 down payment, your loan amount would be $160,000. To find your LTV, you’d divide 160,000 by 200,000 and get 0.8. Multiply 0.8 by 100, to get the LTV ratio of 80%.

When you purchase a home, your LTV will be based on either the purchase price or the appraised value, whichever is lower. If you refinance your mortgage, your LTV will always be based on your home’s appraised value.

What Is A Good Loan-To-Value Ratio?

An LTV of 80% is often thought of as the “ideal” mortgage LTV, because this is the threshold at which you won’t need to pay private mortgage insurance (PMI) on a conventional loan. PMI is an extra cost each month that you’ll need to pay in addition to your monthly payment. If you make a down payment that’s less than 20%, thus making your LTV higher than 80%, you’ll pay a mortgage insurance premium as part of your monthly mortgage payment. Lenders like lower LTVs because it lowers the risk they take when granting a loan.

Your maximum allowed LTV may also depend on whether you’re purchasing or refinancing, and if you’re refinancing, which type of refinance you’re doing. For rate and term refinances, LTV requirements are typically similar to those for purchase transactions. If you’re getting a cash-out refinance, however, you typically will need to keep at least 20% equity in your home so your LTV will still equal 80%.

What Does Low LTV Mean For You and Your Mortgage Lender?

A low LTV is a key indicator for mortgage lenders that you are likely to continue to pay your mortgage. When a mortgage borrower defaults on their loan, the foreclosure process allows the lender to sell the home to try to recoup their losses. The less of their own money they have tied up in the home, the less likely they are to lose money.

Additionally, the more money you, the homeowner, have tied up in your home, the less likely you are to default or walk away.

What If I Can Only Afford A Higher LTV?

Depending on your financial situation, a down payment of 20% might not be possible. Luckily, 80% isn’t the cut-off for the maximum LTV borrowers can have for most loans, and it’s not even necessarily the ideal LTV for every borrower. There are several options for borrowers who need higher LTVs. The Federal Housing Administration offers FHA loans allowing LTVs up to 96.5%, while some conventional loans allow borrowers to go as high as 97% (meaning you’d make a 3.5% down payment).

Additionally, if you qualify for a VA loan for veterans and active military or a USDA loan, which are available in some rural areas, you may qualify for an even lower LTV. It’s possible to have an LTV of 100%, meaning the full cost of the home is financed and you don’t have to make any down payment at all.

In many situations if your LTV is lower than 80% you may be required to carry PMI until the total of your mortgage loan reaches 20% of your loan amount.

Ultimately, the right LTV will balance an affordable down payment, manageable monthly payment and your lender’s approved LTV. As you consider how much you can afford to put down on your home, you’ll need to weigh both upfront costs and long-term costs. Loan opportunities for borrowers with a high LTV might mean you’ll pay more money in the long run because of PMI and higher interest rates.

How To Lower Your LTV Ratio

If you’re looking to lower your LTV before buying so you can get a better interest rate, here are a few options to consider:

• Make a larger down payment: One way to lower your LTV is to make a larger down payment. This could mean borrowing money from a family member, looking for local grant programs to help with costs or reassessing which houses you make offers on.
• Change your timeline: If your savings are limited but you’re set on keeping your LTV at 80% or lower to avoid mortgage insurance and get access to better rates, you might consider pushing back your home purchase to save more for your down payment.
• Reconsider your home options: You can also reduce your home buying budget so that your down payment will account for a larger percentage of the total value of the home you purchase.

Homes typically gain value through appreciation over time, but they can also increase in value if you make improvements to your home. By paying down your mortgage or increasing your home’s value, you can lower your LTV after you purchase a home. If you have a conventional loan with mortgage insurance, you can even have your mortgage insurance premium removed from your monthly payment once you reach an LTV of 80%.

The Bottom Line

Keeping your LTV as low as possible can help you get better rates and a lower monthly payment, though that can be easier said than done. As you shop for a mortgage loan, take some time to consider what you can afford to pay both upfront and on a monthly basis. Though having a low LTV means making a larger down payment, it can ultimately save you money over the life of the loan.

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