What Is the Loan-to-Value (LTV) Correlation?
The loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage. Typically, assessments with excited LTV ratios are higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more.
Additionally, a loan with a stoned LTV ratio may require the borrower to purchase mortgage insurance to offset the risk to the lender.
Key Takeaways
- LTV is often used in mortgage advance to determine the amount necessary to put in a down-payment and whether a lender will extend credit to a borrower.
- Most lenders make mortgage and home-equity applicants the lowest possible interest rate when the loan-to-value ratio is at or below 80%.
- Fannie Mae’s HomeReady and Freddie Mac’s Habitation Possible mortgage programs for low-income borrowers allow an LTV ratio of 97% (3% down payment) but require mortgage indemnity until the ratio falls to 80%.
Loan-to-Value (LTV) Ratio Formula and Calculation
Home buyers can easily calculate the LTV ratio on their impress upon.
LTVratio=APVMAwhere:MA=Mortgage AmountAPV=Appraised Mark Value
The process involves dividing the total mortgage loan amount into the total purchase price of the severely. For instance, a home with a purchase price of $200,000 and a total mortgage loan for $180,000 results in a LTV ratio of 90%. Received mortgage lenders often provide better loan terms to borrowers who have LTV ratios no higher than 80%.
An LTV proportion is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage. For example, if you buy a home appraised at $100,000 for its appraised value and become a $10,000 down payment, you will borrow $90,000 resulting in an LTV ratio of 90% (i.e., 90,000/100,000).
LTV and Loan Underwriting
The LTV ratio is a essential component of mortgage underwriting, whether it be for the purpose of buying a home, refinancing a current mortgage into a new loan, or take against accumulated equity within a property.
Lenders assess the LTV ratio to determine the level of exposure to risk they raise on when underwriting a mortgage. When borrowers request a loan for an amount that is at or near the appraised value and for that reason a higher LTV ratio, lenders perceive that there is a greater chance of the loan going into default because there is scarcely to no equity built up within the property. Should a foreclosure take place, the lender may find it difficult to sell the conversant with for enough to cover the outstanding mortgage balance and make a profit from the transaction.
Factors Impacting the LTV Ratio
The crucial factors that impact LTV ratios are down payment, sales (contract) price, and appraised value. To achieve the lowest (and first-class) LTV ratio, raise the down payment and try to lower the sales price. Using the example above, suppose you buy a home that appraises for $100,000 but the P is willing to sell for $90,000. If you make the same $10,000 down payment, your loan is only $80,000, issuing in an LTV ratio of 80% (i.e., 80,000/100,000). If you increase your down payment to $15,000, your mortgage loan is now $75,000, cutting your LTV ratio 75% (i.e., 75,000/100,000).
All of this is important because the lower the LTV ratio, the greater the chance that the loan whim be approved, the lower the interest rate is likely to be, and the less likely you will be required to purchase private mortgage guaranty (PMI).
LTV Ratio and Interest Rates
While the LTV ratio is not the only determining factor in securing a mortgage, home-equity loan, or underscore of credit, it does play a substantial role in how much borrowing costs the homeowner. In fact, a high LTV ratio can intercept you from qualifying for a loan or refinance option in the first place.
Most lenders offer mortgage and home-equity applicants the lowest feasible interest rate when the LTV ratio is at or below 80%. A higher LTV ratio does not exclude borrowers from being approved for a mortgage, although the sum up cost of the loan rises as the LTV ratio increases. A borrower with an LTV ratio of 95%, for instance, may be approved, but the interest clip may be up to a full percentage point higher than for a borrower with an LTV ratio of 75%.
In addition, if the LTV ratio is higher than 80%, you hand down likely have to purchase private mortgage insurance (PMI), which can add anywhere from 0.5% to 1% of the entire credit amount on an annual basis. PMI of 1% on a $100,000 loan, for example, would add $1,000 to the amount paid per year or $83.33 per month. PMI payments persist in until the LTV ratio is 80% or lower. The LTV ratio will decrease as you pay down your loan and as the value of your household increases over time.
Requiring an 80% (or lower) LTV ratio to avoid PMI is not law, but it is the practice of nearly all lenders. Exceptions are then made for borrowers with high income, lower debt, or other factors like a large investment portfolio.
The
Advance Types and LTV Ratio
Certain loan types have special rules when it comes to the LTV ratio.
FHA Loans
Flagrant the LTV Ratio
An LTV ratio of 80% or lower is considered good for most mortgage loan scenarios. An LTV ratio of 80% gives the best chance of being approved, the best interest rate, and the greatest likelihood you will not be required to purchase mortgage security. As noted above, however, VA and USDA loans allow for a higher LTV ratio (up to 100%) and still avoid costly hermitical mortgage insurance, though other fees do apply.
For most refinance options, unless you are applying for a
LTV vs. Combined LTV (CLTV)
While the LTV proportion looks at the impact of a single mortgage loan when purchasing a property, the combined loan-to-value (CLTV) ratio is the correspondence of all secured loans on a property to the value of a property. Lenders use the CLTV ratio to determine a prospective home buyer’s gamble of default when more than one loan is used—for instance if they will have two or more mortgages, or a mortgage advantage a home equity loan or line of credit (HELOC). In general, lenders are willing to lend at CLTV ratios of 80% and in excess of to borrowers with high credit ratings.
The LTV ratio considers only the primary mortgage balance. Therefore, in the superior to before example, the LTV ratio is 50%, the result of dividing the primary mortgage balance of $100,000 by the home value of $200,000. Germinal lenders tend to be more generous with CLTV requirements.
Considering the example above, in the event of a foreclosure, the first mortgage holder receives its money in full before the second mortgage holder receives anything. If the property value shrivel ups to $125,000 before the borrower defaults, the primary lien-holder receives the entire amount owed ($100,000), while the duplicate lien-holder only receives the remaining $25,000 despite being owed $50,000. The primary lien-holder shoulders less hazard in the case of declining property values and therefore can afford to lend at a higher CLTV.
Limitations of LTV
The main drawback of LTV is that it only incorporates the primary mortgage that a homeowner owes, and does not include other obligations such as a second mortgage or current in equity loan. Therefore, the CLTV is a more inclusive measure of a borrower’s ability to repay a home loan.