What Is a Loan-to-Value Ratio?
The Loan Value Index (LTV) compares the value of a loan you expect to borrow with the appraised value of the property you want to buy. Lenders use LTV to determine how risky a loan is and whether they will approve or reject it. You can also determine if mortgage insurance will be needed.
A higher LTV ratio suggests a higher risk because there is a higher probability of default.
What is the relationship between loan and value?
The loan-to-loan ratio tells you how much property you actually own compared to how much you owe on the loan you made to buy it. The ratio is used for various types of loans, including home and auto loans, and for purchases and refinancing.
LTVs are part of a larger picture that includes:
- Your credit score
- Your disposable income to make monthly payments
- The condition and quality of the asset you are purchasing.
Higher LTV loans are easier to obtain with good credit. Besides your credit, one of the most important things creditors consider is your debt-to-income ratio, your debt payments divided by your income.
This is a quick way for them to find out how affordable a new loan will be for you. Can you comfortably take on these additional monthly payments, or are you doing too much?
How is the loan-to-value ratio calculated?
Divide the loan amount by the appraised value of the asset that guarantees the loan to arrive at the LTV ratio.
For example, suppose you want to buy a house with a fair market value of $ 100,000. You have $ 20,000 available for an upfront payment, so you will need to borrow $ 80,000.
Your LTV rate would be 80% because the dollar value of the loan is 80% of the home's value, and $ 80,000 divided by $ 100,000 equals 0.80 or 80%.
You can find LTV ratio calculators online to help you uncover more complicated cases, such as those involving more than one mortgage or guarantee.
How Loan-to-Value Relationships Work
The more money a lender gives you, the higher the LTV rate and the more risk you are taking. If you are considered a higher risk to the lender, it generally means that:
- It is more difficult to get approved for loans.
- You may have to pay a higher interest rate.
- You may have to pay additional costs like mortgage insurance.
You are probably dealing with a loan secured by some type of collateral if you are calculating the LTV. For example, the loan is secured by a lien on the home when you borrow money to buy a home. The lender can take possession of the home and sell it through foreclosure if you don't make the payments. The same is true with auto loans - your car can be retired if you miss payments.
Lenders really don't want to take your property. They just want some guarantee that they will get their money back one way or another if you don't comply. They can sell the property for less than the top dollar to get their funds back if they only borrow up to 80% of the property's value.
You are also more likely to appreciate your property and continue to make payments when you invest more of your own money in the purchase.
The loan is greater than the value of the asset that guarantees the loan when the LTV ratio is greater than 100%. It has negative equity. In reality, you would have to pay something to sell the asset; I wouldn't get any money from the deal. These types of loans are often called "underwater" loans.
Acceptable LTV Ratios
In general, something close to 80% is the magic number for home loans. Generally, you will need to obtain private mortgage insurance (PMI) to protect your lender if you borrow more than 80% of the value of a home. This is an additional expense, but you can often cancel the insurance as soon as it drops below 80% of the LTV.
Another notable number is 97%. Some lenders allow you to buy 3% down (FHA loans require 3.5%), but you will pay for mortgage insurance, possibly for the life of the loan.
LTV rates generally increase with auto loans, but lenders can set limits or caps and change your rates depending on how high your LTV rate is. In some cases, you can even borrow more than 100% of the LTV because the value of cars can drop more dramatically than other types of assets.
You are using your home equity and effectively increasing the LTV rate by taking out a home equity loan. The LTV will decrease if your home gains in value due to rising house prices, although you may need an appraisal to prove it. Sometimes you can use the land you are building on as equity for a construction loan if you are borrowing money to build a new home.
Limitations of LTV relationships
LTV rates are an implication and not an exact science. There is no line etched in granite that says a loan will be made if the LTV rate reaches a certain percentage, but your chances of loan approval increase if it approaches an acceptable percentage.
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Source: David Boswell Mortgage Advisor
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