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If you’re in the race to becoming a homeowner, you’re bound to be faced with a lot of terms and numbers.
From interest rates, mortgage rate lock, property taxes, and a whole lot more.
Even the mortgage lender who will review your mortgage application has a lot of numbers to evaluate when deciding whether or not to approve your mortgage request. One of such numbers is your loan-to-value ratio (LTV).
Your loan-to-value ratio compares the size of the mortgage you take out and the value of the property being purchased with the mortgage you have taken out.
A borrowers’ LTV ratio is very important in any mortgage application because it helps the lender decide whether to approve a loan and the terms to give a borrower.
Understanding the role of LTV in your mortgage journey can help you decide on the right loan amount and the necessary down payment. In this article, we will explore the term loan-to-value ratio in detail.
What is Loan-To-Value Ratio (LTV)?
The loan-to-value ratio (LTV) is a financial ratio that compares the size of a loan to the worth of the assets that are purchased with the loan.
In relation to the mortgage industry, the LTV is how much money you’re borrowing versus the value of the property you hope to buy with the borrowed funds.
In a nutshell, your LTV ratio tells you how much of a property you own compared to the amount you owe on the loan you took out to buy it.
LTV is important because it helps online mortgage lenders stay within the LTV ratios of specific loan programs.
For example, it is common for lenders to approve up to 80% for Fannie Mae and Freddie Macloans.
So, if your LTV ratio is higher than 80%, you may have to purchase mortgage insuranceto protect the lender if you default in the repayment of your loan.
How Do You Calculate Loan-to-Value Ratio?
When calculating LTV, you use the home’s appraised value to estimate the home’s value. Remember that the appraised value is not always the same as the purchase price of the house.
The appraised value may be higher or lesser than the amount you pay to buy the house.
For example, let’s say you want to buy a home for $200,000 and make a down payment of $15,000. This means that you will need a mortgage of around $185,000.
To get your LTV ratio, you take the mortgage amount and divide it by the home sale price. That is:
$185,000 ÷ $200,000 = .0925 or 93% approximately
Below is a more detailed representation of the calculation:
LA (loan amount)/APV (appraised value) = LTV
| Variables | Prospective Home ($) |
|---|---|
| Appraised Home Value | $200,000 |
| Loan Amount | $185,000 |
| Calculation | $185,000/$200,000 = 0.925 |
| LTV | 93% |
In the above example, the LTV ratio is relatively high, which means a higher risk on the lender’s part.
With a 93% LTV ratio, you will have to deal with a higher interest rate and private mortgage insurance.
How Loan-to-Value Ratios Work
The workings of LTV ratios are straightforward. The more money a lender borrows you to purchase your home, the higher your LTV ratio will be.
And the higher your LTV ratio, the higher the risk the lender is taking on.
This is one of the reasons why you get a lower interest rate and better loan terms when you are putting down $60,000 on a $150,000 home versus when you’re putting $15,000 on the same $150,000 home.
When your loan-to-value ratio is on the very high side, you will have to deal with the following issues:
- Difficulty in getting loans
- Deal with a high-interest rate
- Pay for additional fees, such as mortgage insurance which may run into thousands of dollars annually.
For most lenders, the lower your LTV ratio, the more likely you’ll be committed to paying off the loan because you have put in a considerable amount of your own money into the home purchase.
What Is a Good LTV Ratio? Varies By Loan
If you’re taking out a mortgage for the very first time, you may be asking the question, what is considered an excellent loan-to-value ratio?
Every mortgage loan type comes with its own recommended LTV ratio. This section will itemize what is regarded as a good LTV ratio across the available mortgage loan options.
| Loan Type | LTV Maximum |
|---|---|
| Conventional Loan | 80% |
| FHA Loan | 96.5% |
| VA Loan | 100% |
| USDA Loan | 100% |
| Jumbo Loan | 10 - 89.99% |
Conventional Loans
Conventional loans are loans that conform to the lending standards set by Fannie Mae and Freddie Mac.
This type of loan represents a vast majority of all the mortgages underwritten in the U.S. With conventional loans, lenders often require a maximum LTV ratio of 80% for borrowers hoping to avoid mortgage insurance. However, it is possible to get a conventional loan with an LTV ratio of up to 97%.
FHA Loan
Insured by the Federal Housing Administration, FHA loans allow borrowers to get away with a high LTV ratio due to its down payment requirement of 3.5%.
However, the maximum LTV ratio is 96.5%. It is also worth noting that FHA loans require borrowers to carry FHA mortgage insurance premiums regardless of their down payment.
VA Loan
VA loans are government-backed mortgages aimed at members and veterans of the U.S. armed forces.
Backed by the Department of Veteran Affairs, VA home loans are among the few mortgage loans that allow borrowers to get a loan with a 100% loan-to-value ratio. This means that you don’t need to put down any money to get a VA loan.
USDA Loan
USDA loans are issued by the U.S. Department of Agriculture and are targeted at helping individuals in rural areas purchase a home.
And since USDA loans require zero down payment, borrowers can get a loan with up to 100% LTV.
Jumbo Loan
Jumbo loans are mortgage loans that exceed the conforming limits of Fannie Mae and Freddie Mac, two government-sponsored enterprises.
Since jumbo loans offer some of the biggest loan amounts, it comes with a greater risk for lenders than other loan options.
This is one of the reasons why jumbo loans have strict LTV requirements. You’ll need an LTV ratio of around 70% to 89.99% max to get a jumbo loan.
>> More: How to Choose the Best Mortgage
How to Lower Your Loan-to-Value Ratio
Whether you’re buying a new house or refinancing your existing mortgage, there are several ways you can lower your loan-to-value ratio.
Remember that reducing your LTV ratio gives you access to more loan options and better loan terms. Below are some of the ways to reduce your LTV ratio.
Make a Larger Down Payment
When buying a home, the larger your down payment, the lower your loan-to-value ratio will be.
When applying for a mortgage, mortgage lenders are more focused on your down payment because it reveals the level of risk in giving you the loan.
For most lenders, a borrower with a huge down payment is less likely to default on their loan repayments.
More importantly, a larger down payment increases the home equity you have in your home. For example, if you make a down payment of $40,000 on a home with an appraised value of $160,000, your LTV on a $120,000 mortgage loan will be 75%.
In a nutshell, the larger your down payment, the lower your LTV ratio. And the lower your LTV ratio, the better your chances of getting an outstanding mortgage loan.
Choose the Right Mortgage
If you cannot provide a considerable down payment or find a less expensive house, you may want to consider mortgage loans with lower down payment requirements.
Loan programs like USDA and VA loans do not require a down payment, but you must meet the necessary eligibility requirements.
Also, you can take advantage of FHA loans and conventional loans that require as little as a 3.5% down payment.
Buy a Cheaper House
If you’re working with a slim budget and unable to make a substantial down payment, you may consider opting for a less expensive home.
Going for a cheaper house will save you more money for a larger down payment, thereby lowering your LTV ratio.
Let’s say you have $20,000 to use for your potential home down payment; below is how the price of a home impacts your LTV ratio.
| Variables | Case Study 1 | Case Study 2 |
|---|---|---|
| Purchase Price | $200,000 | $100,000 |
| Down Payment | $20,000 | $20,000 |
| Loan Amount | $180,000 | $80,000 |
| Calculation | $180,000/$200,000 = 0.90 | $80,000/$100,000 = 0.80 |
| LTV | 90% | 80% |
What Does 60% LTV Mean?
When applying for a mortgage loan, a 60% loan-to-value ratio means that you can borrow up to 60% of the home’s appraised value and you have deposited 40% of the home value.
For example, let’s say you find a home with an appraised value of $300,000 and made a down payment of $120,000.
You’ll need to borrow $180,000. In calculating your LTV, you will divide your down payment by the home appraised value.
That is, $180,000 divided by $300,000 equals 0.6 or 60%.
Like we mentioned in the earlier part of this article, the lower your LTV ratio, the broader your choices of mortgages will be. With an LTV ratio of 60%, you are more likely to receive a lower interest rate.
What Does Up to 80% Loan-to-Value Mean?
It is common to see lenders and loan programs advertise that intending home buyers can get mortgage loans with up to 80 percent loan-to-value ratio.
This means that borrowers can borrow up to 80% of the appraised value of their potential home.
Bottom Line: What Is Loan-to-Value Ratio?
Your loan-to-value ratio reveals the size of your home loan compared to the appraised value of the home you intend to purchase.
And the lower your LTV ratio, the higher your chances of getting approved for a mortgage.
Keeping your LTV ratio at 80 percent or below is one of the many ways to avoid paying for mortgage insurance and high-interest rates.
Before applying for a mortgage loan, it is advisable that you save up for a more significant down payment, shop across lenders, and find homes within your budget.
While your LTV ratio is a small piece of a bigger pie, it can impact the money you spend monthly on mortgage payments.
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