If you’re looking to take out a mortgage, you will no doubt encounter the concept of the “Loan-to-Value Ratio”, or LTV. The LTV is a metric that lenders use to assess risk and determine the interest rate they will offer the borrower. In general, the higher the LTV, the riskier the loan is perceived to be. This results in higher interest rates, as the lender seeks to balance the risk of a potential default. Some lenders will require borrowers with a very high LTV to purchase private mortgage insurance as an added measure.
Understanding your LTV is crucial for anyone looking to take out a mortgage. Not only will it help you find the best possible interest rate on your loan, but it will also give you an idea of how much money you will need for a down payment.
Calculating Your LTV Ratio
Finding your LTV ratio is surprisingly easy. All you need to know is the Appraised Property Value, or APV, of the home in question and the value of the mortgage you are looking to take out. Remember, the value of the mortgage is not necessarily the value of the home. Most homebuyers make a down payment in cash when purchasing the property, which counts against the mortgage.
This means that if the price of a house was $200,000, and you put a $50,000 payment down, your mortgage would only be $150,000. Once you know the APV and your Mortgage Value, you can calculate the LTV. Simply divide the Mortgage Value (MV) by the APV, and the result, expressed as a percentage, will be your LTV.
LTV = MVAPV
So, let’s use the example from earlier. The APV of the home is $200,000, and the Mortgage Value is $150,000. Using our formula, we get .75, or an LTV ratio of 75%.
Interpreting your LTV Ratio
Remember, the LTV ratio is used by lenders to determine risk. The riskier the loan, the higher the interest rate. The higher the interest rate, the more money the borrower will pay in the long run. Therefore, it’s important to try to get your LTV ratio to the optimal level before applying for a mortgage. Most lenders consider 80% or below to be optimal, and will extend the best possible rates to borrowers with a LTV ratio in this range.
The LTV ratio is also used when a borrower is attempting to refinance an existing loan, or take out an additional loan against the equity they have built up in the property. Having a lower LTV ratio means reduced payments over the long run, but it does require the homebuyer to have enough money up front to cover a larger down payment. A higher LTV may result in higher interest, but it will enable a homebuyer to purchase a property sooner and with less money saved.
Some buyers may be approved for lower interest rates despite having a high LTV ratio. This is typically because they have a high income or sizable investments, as the lender is confident in their ability to pay back the loan.
In the event that your LTV ratio is over 80%, most lenders will require that you purchase private mortgage insurance. This is an added cost to the monthly mortgage payment that covers a potential default. Borrowers will be required to hold the insurance until they have built up enough equity to reduce the LTV ratio to 80% or below. To avoid this, it might be worth waiting until you’ve saved enough money to make a larger down payment.
Combined LTV and Other Types of LTV
The normal LTV ratio only considers one loan on a property. If you were to take out an additional mortgage or Home Equity Line of Credit on a home, then you would need to calculate your Combined Loan to Value Ratio, or CLTV. Essentially, the combined value of the loans is used to calculate the CLTV, using the same formula. Certain loans, such as VA, FHA, and USDA loans, allow for higher LTV ratios without incurring the need to take out private mortgage insurance.
Maintaining a Healthy LTV Ratio
Your LTV ratio is very important if you want to get a good interest rate on your mortgage. A person with a 90% LTV ratio might receive an interest rate on their loan that is up to 1% higher than a person with a 70% LTV ratio. Over the lifetime of the mortgage, this will be a significantly higher cost. If you are required to take out private mortgage insurance, the extra cost will be even higher. Working with a dedicated mortgage expert can help you make the most of your LTV ratio. An experienced broker will be able to find you the best interest rate possible, even with a higher LTV ratio.
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