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Loan to Value Definition
In simple terms, LTV is a risk assessment ratio that mortgage companies, banks, and other lenders look at to determine whether or not to approve a mortgage loan. It describes the amount of the mortgage loan expressed as a percentage of the home's value. It is applied to home purchase loans as well as when a mortgage is refinanced.
How is LTV Calculated?
Calculating the LTV ratio is a matter of simple division. In order to get an accurate LTV, the property's appraised value and the loan amount requested must be defined. The loan amount is divided by the value of the property and the resulting figure is expressed as a percentage. That said, lenders also look at the reason for the mortgage and adjust the calculation accordingly.
In most cases, LTV is based on the sales price of the home for a purchase. However, if the home appraises for a lower value than the purchase price, the lower appraised value is used in the calculation. For a refinance, the LTV is calculated based upon the home's appraised value. Following are examples of LTV calculations:
If a home is appraised at $100,000 and the borrower is asking for a mortgage loan, either for a purchase or a refinance, of $85,000, the LTV would be 85%. The math looks like this: $85,000 divided by $100,000 = 85%.
A home with a purchase price of $100,000, appraised at $95,000 with a loan amount of $85,000 would have an LTV of 89%. Calculated as follows: $95,000 divided by $85,000 = 89%.
How Does LTV Affect A Mortgage Loan?
The purpose of calculating the LTV ratio is for the lender to determine the level of risk they'll undertake when approving a mortgage loan. When the LTV is close to the appraised value of the home, it has a higher LTV, and is therefore considered a greater risk. The reason for this is simply that if the loan goes into default and the lender forecloses, there is little to no equity built up. They will have a harder time selling the home for a figure that would cover the mortgage balance as well as making a profit.
Borrowers who are able to obtain a lower LTV often find that the approval process is faster, and that the interest rate they qualify for is lower. As a general rule of thumb, lenders are more apt to offer a mortgage or refinance loan applicant a lower interest rate if the LTV is at, or below, 80%. This, of course, depends on other factors such as the borrower's credit history and ability to repay the loan based on their financial information.
How Can a Borrower Lower the LTV Ratio?
In the case of a mortgage refinance, there is little a homeowner can do to lower the LTV ratio as it is based on the home's appraised value. However, when it comes to making a home purchase, a borrower can lower the ratio simply by making a larger down payment, thus decreasing the amount they'd need to borrow. For example:
A home with an appraised value of $100,000, with a sales price of $95,000 and a down payment amount of $20,000 would have an LTV of 75%. The calculation would look like this: $95,000 - $20,000 = $75,000 divided by $100,000 = 75%.
Conclusion
When applying for a mortgage loan or mortgage refinance, there are many factors that go into the decision making process for lenders. Credit history of the borrower, ability to repay the loan, and loan-to-value ratio are among the most important. Borrowers who understand these factors are in a much better position to negotiate a good rate and terms that they can live with.
Please note, by refinancing your existing loan, your total finance charges may be higher over the life of the loan.