What is LTV?

July 28, 2022

LTV stands for loan-to-value. This term refers to the ratio between the loan amount and the total value of the purchase being financed.

Lenders use LTV to determine how much risk they’re taking on when providing a borrower with a loan. While LTV is utilized mainly for mortgages, it can be used for other types of loans as well. If the loan-to-value ratio is high, this means that the lender is taking on more risk. 

The reason that a high LTV loan is considered to be riskier is because the lender may not get their money back if the borrower defaults on their loan.

Why LTV Matters for Mortgages

When you’re looking to make an offer on a home, among the most important financial terms that you’ll want to understand is loan-to-value, which can play a role in your ability to qualify for a loan.

The LTV ratio is a basic assessment that tells lenders how risky it is to provide borrowers with a mortgage. Borrowers who have high LTV ratios are typically believed to have a higher amount of risk. In most cases, a high LTV can lead to higher interest rates.

The following guide tells you everything you need to know about LTV and what it means for the mortgage application process. 

How LTV is Calculated

Knowing what LTV means isn’t enough to understand how it’s calculated.

Your loan-to-value ratio can be used to identify how much you owe on an existing mortgage or what the LTV ratio will be for a future mortgage. The LTV ratio formula is written as:

Loan balance ÷ appraised value = LTV

If you’re set to receive a $200,000 loan on a home that’s valued at $250,000, the loan-to-value equation would be displayed as:

$200,000 ÷ $250,000 = .80

You would then convert .80 to a basic percentage, which means that your LTV ratio would be 80%.

What is LTV used for?

LTV is an assessment of risk that can be used for any collateralized loan, but most people will encounter LTV when shopping for a mortgage.

Some lenders will also use this ratio when providing loans for auto purchases. In this situation, you can trade another vehicle in with the dealer during the sale to lower your LTV.

If you want to reduce the amount of risk a lender takes on when providing you with a mortgage, it’s general practice that you provide a large down payment. Anything that you can do to reduce the LTV increases your chances to be approved for a mortgage.

If you’re buying a home that’s valued at $300,000, making a $100,000 down payment can provide you with a much lower LTV compared to a $20,000 down payment. 

Even though lenders prefer to provide mortgages to borrowers with a low LTV, there are ways to mitigate a certain amount of the risk that the lender takes on when approving a mortgage with a high LTV.

An excellent credit score, strong payment history, and consistent credit use can all contribute to a high-LTV loan with reasonable terms and a relatively low interest rate. 

What LTV Do Lenders Look For?

In most cases, lenders want borrowers to have an LTV of 80% or lower, meaning the borrower is purchasing an asset with at least 20% of their own cash.

For example, a $100,00 down payment on a home that’s valued at $500,000 would result in a LTV of 80% or lower.

Keep in mind that some mortgage loans don’t come with high down payment requirements. It’s possible to be approved for an FHA loan even if you have an LTV that’s as high as 96.5%. Other government-backed loans like VA loans and USDA loans can provide borrowers with 100% financing, which means no down payment is required if certain qualifications are met. 

While lenders oftentimes provide borrowers with a mortgage even if their LTV is higher than 80%, having a lower LTV will allow you to obtain a conventional mortgage without needing to pay for private mortgage insurance. 

How to Lower LTV

1. Purchase a Less Expensive Home

If possible, you could consider buying a more affordable home. If you were set to buy a $300,000 home with a down payment of $50,000, you could further reduce your LTV by instead buying a $250,000 home with a $50,000 down payment. This strategy also avoids paying private mortgage insurance.

2. Make a Sizable Down Payment

LTV is based entirely on the total value of your home and the loan amount. Making a larger down payment immediately reduces your LTV.

4. Make More Payments

Making additional payments over the course of the loan can help quickly pay off your mortgage and ultimately reduce the LTV. While this doesn’t help with interest rates before you’ve obtained a loan, it can help to eliminate private mortgage insurance faster.

LTV Limitations

There are several issues with the LTV ratio that can be problematic when lenders use it to determine a borrower’s interest rate.

The main limitation is that the LTV ratio only takes the primary mortgage into account as opposed to other financial obligations from a home equity loan or second mortgage. 

Another ratio that has proven to be popular as a replacement for LTV is CLTV, which takes many more factors into account when determining if a borrower is able to repay their loan. Along with additional loans or mortgages that are placed on a property, CLTV also considers HELOCs and home equity loans. This particular method is calculated by combining all loans and dividing the number by the total property value. 

The loan-to-value ratio is a factor in determining mortgage approval and interest rates. 

With this information in hand, you can ask your lender what interest rate you’ll receive. If the interest rate is higher than you’d like, consider your options for improving your LTV.

This material is provided for informational and educational purposes only.  It is not intended to be investment advice and should not form the basis of an investment decision.  Any examples included are included for illustrative purposes only. 

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