Toni F. Ryan
What is Loan-to-Value (LTV) and why it matters when securing a home mortgage?
When you get ready to apply for a loan to buy a home or refinance your current mortgage, you're going to notice many unfamiliar terms popping up throughout the process.
In this series - we're giving you easy answers so you feel confident and educated as you navigate the home mortgage process.
What is LTV or Loan-to-Value?
LTV is a ratio that lenders and financial institutions use to assess lending risk before approving a loan. The LTV ratio compares two values:
the loan amount and
the appraised property value
The LTV ratio is equal to the loan amount divided by the appraised property value. It is usually expressed as a percentage.
LTV ratio = Loan Amount / Appraised Property Value
Let's look at an example:
If you want to buy a home with an appraised value of $400,000 and planning to make a down payment of $20,000 --- the amount you will be financing is $380,000 (400,000 - 20,000 = 380,000)
This means the LTV ratio can be calculated as:
LTV ratio = 380,000 / 400,000 = 95%
Now that you have your ratio - what does it mean?
Your LTV ratio is a critical component in qualifying for a mortgage. Lenders look at the LTV ratio to determine the level of risk the loan will have.
The higher the ratio = the higher level of risk because there is very little equity built up within a property.
The lower the ratio = the lower level of risk to the lender because there is more equity in the property.
So let's go back to our example from above. A LTV ratio of 95% is pretty high. Lenders may not offer the lowest rate to this borrower and require private mortgage insurance (PMI) to help mitigate the risk. PMI is an added month fee. If the borrower were to increase their down payment to $80,000, the new LTV ratio would be:
LTV ratio = 320,000 / 400,000 = 80%
An LTV of 80% is less risky. Most lenders offer borrowers the lowest possible interest rates when their LTV ratio is at or below 80% however this is only one of many factors that lenders use to consider loan approval.
Please note that a higher LTV doesn't mean a loan will not get approved or qualify for a competitive rate. Every lender has their own requirements and programs which is why your loan officer will be able to advise you directly about your own mortgage scenario.
Different Loan Types may require a different LTV Ratio
You may not be aware but there are different kinds of loan types (besides the standard conventional mortgage) and the required LTV ratio can vary.
FHA Loans are mortgages designed for low and moderate income borrowers and usually require a lower minimum down payment. FHA loans are issued by an FHA-approved lender and insured by the Federal Housing Administration (FHA). This can allow the LTV ratios to be much higher and often require a mortgage insurance premium (MIP) but it can be a great option to get into a home especially when home values are rising and will allow you to build equity to be able to refinance in the future.
VA Loans are available to current and former military and do not require private mortgage insurance even though the LTV ratio can go as high as 100%. VA loans do have additional fees and requirements but it's a valuable option to consider if you are a veteran or currently serving.
USDA Loans are available to those who live in rural areas. This special program allows for higher LTV ratios - up to 100%. Check with your Loan Officer to see if this loan program is available in your area.
Special Conventional Loans from Fannie Mae and Freddie Mac have select programs (the HomeReady and Home Possible options) for low-income borrowers and allow for LTV's up to 97%.
Do you need to know your LTV?
As we mentioned above, you only need to know 2 numbers to calculate your LTV (your loan amount and the appraised property value) however, don't be surprised if these numbers change throughout the mortgage process.
A few things to keep in mind:
Your loan officer will work with you to estimate your home value before you have an appraisal done. If the appraisal comes in at a different value, this will affect your LTV.
Your loan officer will give you different options based on the size of your down payment. Depending on your goals, financial profile, etc. she will give you payment and rate options so you can make the best decision. Hint: a larger down payment isn't always the best choice.
Private Mortgage Insurance isn't always a bad thing. If home values are increasing, paying PMI for a short period can be more financially smart than an initial higher down payment. Talk to your loan officer about this strategy.
Don't get scared by the Loan-to-Value ratio and the math involved. Instead of viewing it as a mystical number assigned to your loan application that will determine a "Yes or No," work with your loan officer closely and ask plenty of questions. Your mortgage consultant is there to walk you through each step of the process and should give you a strategy that supports your short and long term goals.
And of course, you can always ask me questions at toni (at) toniryan.com
ABOUT THE AUTHOR
Toni F. Ryan | NMLS#230507
Senior Loan Officer | Pinnacle Home Loans
Toni F. Ryan has over 25 years experience in mortgage lending - both on the wholesale and retail levels. She believes that education is key to making the best decision for YOU! She shares her insight into the lending world here and encourages your feedback. Don't forget to connect on Facebook - Instagram and TikTok