Loan to Value Ratio

Monday mortgage Q&A: “What is the loan to value ratio?”

You’ve probably heard the phrase loan-to-value ratio get thrown around a lot lately, what with all the stories of negative equity and underwater borrowers.

Put simply, loan-to-value ratio, or “LTV ratio,” is the loan amount divided by the purchase price or appraised value of the property.

Let’s look at an example:

Property Value: $500,000
Loan Amount: $350,000
Loan to Value Ratio (LTV): 70%

In the above example, the loan-to-value ratio is 70 percent, meaning the borrower has a loan for 70 percent of the property value, and 30 percent remaining home equity, or ownership, in the property.

Lower Loan-to-Value Means More Ownership

Essentially, the lower the loan-to-value ratio, the better, as it means you have more ownership (home equity) in the property.

Not only that, but banks and mortgage lenders also set up pricing adjustment tiers based on loan-to-value ratio.

In other words, if you’re being hit for having a less than stellar credit score, that hit will grow larger as the loan-to-value ratio increases (higher LTV ratio = greater risk).

So if your mortgage rate is bumped a quarter of a percent for a loan-to-value ratio of 70 percent, that hit may be increased to a half a percent if the loan-to-value ratio is 80 percent.

This can certainly raise your interest rate in a hurry, so you’ll want to look at all possible scenarios with regard to down payment and loan amount.

Looking at that above example again, if you were to add a second mortgage of say $50,000, the combined loan-to-value ratio, or CLTV, would be 80 percent.

Simple math: $350,000 + $50,000 = $400,000 / $500,000 = 80% CLTV

Sometimes borrowers elect to break up home loans into a first and second, known as combo mortgages, to keep the loan-to-value in check, thereby reducing the interest rate and/or avoiding private mortgage insurance.

Keep in mind that banks and lenders also have LTV limits, meaning they won’t allow homeowners to borrow more than say 80, 90, or 100 percent of the property value (these LTV limits have come down since the mortgage crisis got underway).

And finally, those underwater or upside down borrowers you hear about; they owe more on their mortgage than the property is currently worth.

This can happen due to negative amortization and/or home price depreciation.

A quick underwater loan-to-value ratio example:

Property Value: $400,000
Loan Amount: $500,000
Loan to Value Ratio (LTV): 125%

The problem with these borrowers is that they have little incentive to stick around, even with a modified mortgage payment, as they’re so far in the red there’s little hope of recouping losses.

And it just so happens that the Home Affordable Refinance Program allows loan-to-values up to 125 percent.

Of course, as property values increase, the LTV ratio will eventually fall.  So there is some hope for borrowers in this situation, assuming they can stomach it.