Loan-to-value (LTV) ratio is an evaluation of lending risk which is considered by financial institutions and other lenders to examine the approval of any mortgage. Assessments with high LTV ratios are generally considered to be higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more. In addition, a loan with a high LTV ratio may require the borrower to purchase mortgage insurance to offset the risk to the lender.
In simple words, the LTV ratio is the proportion of the property value that a lender can finance through a loan. This ratio is used by financial institutions (banks, housing finance companies, non-banking finance companies) to assess their risk in lending a home loan to you as a borrower.
Why is LTV Important?
A lot of times home loan borrowers come across several criteria set by lenders, primarily related to annual income required to be eligible for a home loan, the minimum down payment to be raised by borrower, a good credit score, etc. Apart from this, one of the important criteria in home loan is the lender’s maximum loan-to-value (LTV) ratio.
The main reason for using the LTV ratio for a lender is to calculate that they do not lend a higher amount than the actual price of the property. For a lender, if LTV increases the perceived risk of borrower default increases.
How to Calculate LTV Ratio?
The Loan to Value or LTV ratio is the ratio of the loan amount against the value of an asset purchased.
LTV= total loan amount/ value of an asset purchased
What Exactly Is a Good Loan-to-Value Ratio?
What’s considered a good LTV ratio varies depending on the type of loan you’re applying for. If you’re applying for a conventional home loan, a decent LTV ratio is 80%. That’s because many lenders expect borrowers to pay at least 20% of their home’s value upfront as a down payment.
The loan-to-value ratio is just one factor that home loan lenders consider when deciding whether to approve a borrower for a home loan or a refinance loan. There are other factors that lenders take into account, such as credit scores. But if you want a low mortgage rate (and you want to avoid paying PMI), it’s best to make a sizable down payment and aim for a low loan-to-value ratio.
What If Your Loan-to-Value Ratio Is Too High?
Having a high LTV ratio can affect a homebuyer in a couple of different ways. For one thing, if your LTV ratio is higher than 80% and you’re trying to get approved for a conventional mortgage, you’ll have to pay private mortgage insurance (PMI). Fortunately, you’ll eventually be able to get rid of your PMI as you pay down your mortgage. Your lender must terminate it automatically when your LTV ratio drops to 78% or you reach the halfway point in your amortization schedule.
If your LTV ratio is too high, taking out a mortgage loan will also be more expensive. By making a low-down payment, you’ll need a bigger loan. In addition to paying PMI, you’ll probably pay more interest.
How to Get a Lower LTV?
There are many ways in which you can lower your loan-to-value ratio, some of these are listed below:
Increase your down payment: If your loan-to-value ratio is relatively high, it may be a good idea to increase your down payment before you take out a loan. If you don’t have enough money to do that, consider waiting until you can save more.
Lower your purchase price: If you don’t have a big enough down payment and can’t wait to save more, you can decrease your LTV by selecting a car or home that costs less. Compromising a bit on things like square footage (for a home) or mileage (for a car) could make you financially stronger in the long run.
Get your home revalued: Ideally, your home will appreciate over time — it’s possible for the value to go up significantly within a few years of buying it. If you want to refinance your home or take out a home equity loan or line of credit, a revaluation can help you get a better idea of your home’s value and your equity in your home. It could also give you an idea of whether your LTV has decreased enough to request to have your PMI removed.
Why is the LTV ratio considered important?
The higher your LTV ratio, the riskier your loan may appear to lenders. Also, when you make a smaller down payment, you have less equity or ownership in your property. That can be problematic for the lender because if you default on a loan, the lender might not be able to recoup its loss by selling your property.
Is it possible to get better interest rates by managing LTV?
If, for example, you want to refinance your mortgage or auto loan, a lower LTV ratio may help you qualify for better interest rates.
How to get an ideal LTV?
LTV ratio requirements will vary by loan. But having a lower LTV ratio is one factor that could help you get more favourable loan terms. By increasing your down payment, lowering purchase price, and even by getting your home revalued, you can adjust LTV to an ideal level.
While applying for a loan, it’s important to understand the financial implications of a high loan-to-value ratio. Lowering your LTV ratio may put you in a better financial position to receive a better interest rate and help you save money over the life of your loan.