What Is the Loan-to-Value Ratio?

October 12, 2009 17 Comments »

loan to value ratio

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.

Regardless of what’s going on in the housing market, you should know this important term when applying for a mortgage to ensure you get the best deal as it can greatly affect pricing and loan eligibility.

How to Calculate Loan-to-Value Ratio

Put simply, the loan-to-value ratio, or “LTV ratio” as it’s more commonly known in the industry, is the mortgage loan amount (or balance) divided by the purchase price or current appraised value of the property. When calculating it, you will wind up with a percentage.

It’s actually very easy to calculate (no algebra required) and takes just one step!

Let’s calculate a typical LTV ratio:

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

In the above example, we would divide $350,000 by $500,000 to come up with a loan-to-value ratio of 70%.

Using a calculator, simply enter in $350,000, then hit the divide symbol, then enter $500,000. You should see “0.7,” which translates to 70%.

This means the borrower has a loan for 70 percent of the property value, with the remaining 30 percent the home equity portion, or ownership in the property.

LTV ratios are extremely important when it comes to mortgage rate pricing because they represent how much skin you have in the game, which is a key risk factor.

A Lower LTV Ratio Means More Ownership, Better Rate

Essentially, the lower the loan-to-value ratio, the better, as it means you have more ownership (home equity) in the property.  Someone with more ownership is less likely to fall behind on payments or foreclose, seeing that they have a greater equity stake, aka financial interest to keep paying.

Not only that, but banks and mortgage lenders also set up pricing adjustment tiers based on the LTV ratio.  Those with lower LTV ratios will enjoy the lowest interest rates available, while those with high LTVs will be subject to higher costs and rates.

For example, if you’re being hit for having a less-than-stellar credit score, that adjustment 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 80%, that hit may be increased to a half a percent if the LTV ratio is 90%.

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 to keep your LTV ratio as low as possible.

80% LTV Is a Very Important Threshold!

Most borrowers (who are able to) elect to put 20% down, as it allows them to avoid the need for mortgage insurance and the higher pricing adjustments often associated with LTVs above 80%.

But you don’t necessarily need to put 20% down to enjoy the benefits of a low-LTV mortgage.

Looking at the above example again, if you were to raise the first mortgage amount to $400,000 and add a second mortgage of $50,000, the combined loan-to-value ratio, or CLTV, would be 90%.

Simple math: $400,000 + $50,000 = $450,000 / $500,000 = 90% CLTV

You would have a first mortgage at 80% LTV, and a second mortgage for an additional 10% LTV, making the CLTV 90%.

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

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

As it stands, you can get an FHA loan as high as 96.5% LTV, a conventional loan as high as 97% LTV, and a VA loan or USDA loan at 100% LTV (no money down).

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%

As you can see, the underwater borrower has a LTV ratio greater than 100% (negative equity), which is a major problem from a risk point of view.

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

However, it just so happens that the Home Affordable Refinance Program allows loan-to-values up to 125 percent.  And now there’s no LTV limit!

So there are options, as long as your loan is owned by Fannie Mae or Freddie Mac.  It just means they are way behind new homeowners entering the market in terms of building equity.

For the record, borrowers can lower their LTV in two ways.  One way is simply by paying down the mortgage balance, whether on schedule or by making extra payments.  At the same time, if home values increase, the LTV is lowered that way as well.

Read more: 10 ways to build home equity.

17 Comments

  1. Sabastian Garcia January 21, 2015 at 10:58 am -

    HELLO excellent explanation on this page! I have a question though and I’m hoping you can help me out because I’ve been looking for the answer and haven’t found any info on it…well. Here it is.
    how do you calculate both the dollar amount and percent amount of equity if: you want to buy a house. an you take out a mortgage.

    EX: house cost $200,000 Down payment $40,000
    Loan $160,000
    three years pass: you’ve paid $10,000 off the loan. the house has appreciated by double so..
    house value $400.000
    My Equity as a Dollar amount is??
    MY Equity as a percent is??
    How did you figure those two questions out!??
    thanks a lot!!!!!

  2. Colin Robertson January 21, 2015 at 11:52 am -

    Hi Sabastian,

    I would take $160,000 (your original loan amount) and subtract $10,000, assuming that $10,000 paid off was toward principal (if not take your current loan balance). That should leave you with a loan balance of $150,000. Then I would divide $150,000 by your new home value of $400,000 and come up with 37.5% LTV. Your dollar amount of equity would be $400,000 – $150,000, or $250,000.

  3. Laura R. January 27, 2015 at 9:09 pm -

    I am 2 1/2 years post short sale and would like to buy another home. I’m looking to purchase home within $400-$500,000 and have about $300,000+ for a down payment. My credit score is 720. With Fannie Mae requirements recently changing requiring a 4 year wait period regardless of LTV, are there any lenders that will accomodate me?

  4. Colin Robertson January 28, 2015 at 10:42 am -

    Laura,

    Some waiting periods are shorter with extenuating circumstances, but if that doesn’t apply to you, a portfolio lender might be willing to extend financing. They keep the loans on their own books and are thus willing to originate loans other agencies like Fannie/Freddie won’t. With that size down payment, you’ll hopefully have some options in the private market.

  5. Julie June 19, 2015 at 1:21 pm -

    Hello I am currently working with an income of 150,000 and looking to purchase a new construction around 360,000 max. I have student loans almost 200,000 but have a very low payment due to the loan forgiveness program and my occupation. Should I sell my house and take the 50,000 equity and put it down on the new house or should I rent out my home for extra income.

  6. Colin Robertson June 19, 2015 at 2:28 pm -

    Julie,

    It depends if you want to keep the existing home or if you need to sell to fund the construction loan. You might be able to pull equity from the existing property to fund the construction loan. Might want to sit down with someone well versed in construction loans to weigh all your options.

  7. Bob Austin July 7, 2015 at 3:34 pm -

    We owe 350000 on a Home valued at 460000. Would like to remodel and double the size of the house if not a little more. What are some options to accomplish this.

  8. James January 27, 2016 at 10:57 am -

    In my experience, adding on to your home rarely makes financial sense. You are typically better off moving and buying a larger home. The price you pay per square foot for quality construction to add on is almost always more than what you pay to purchase a home. Unless you hire a really good, high dollar architect and have a home that’s conducive to adding on, enlarged homes often look awkward and can be difficult to resell. If you really love the home you’re in and don’t want to move, find ways to use your space more efficiently. Don’t waste your money adding on.

  9. James January 27, 2016 at 11:02 am -

    You shouldn’t be spending that much on a new home if you have that much student loan debt. Stay where you are for now and focus on paying off your student loans. You don’t need a new house. You know it’s the right thing to do. If the market tanks again, you’ll have a huge problem.

  10. James January 27, 2016 at 11:05 am -

    If you have that much cash available, you should use it to pay back the bank what they lost on your short sale. That should be considered as bad as a bankruptcy and cut you off for at least 7 years. And people say the banks are the criminals….

  11. Terri Williams March 15, 2016 at 3:16 pm -

    Are there any institutions that will refinance at a ltv ratio of less than 80%?

  12. Colin Robertson March 16, 2016 at 9:53 am -

    Terri,

    A lower LTV indicates less risk meaning more lenders should offer financing…unless you’re talking about a HARP refinance that must be 80% LTV or higher.

  13. achia May 12, 2016 at 6:48 pm -

    Hi Colin,
    I have a question about mobile/manufactured homes. I noticed a lot on Zillow in the florida area.
    Example
    $8,000 Price
    Price cut: -$3,500 (4/25)
    Zestimate®: $131,699. If they Zestimate it’s actually worth 131699. How would this work LTV wise?

  14. Chris July 15, 2016 at 6:32 am -

    Hello Colin,
    Maybe you can help me understand my loan. I am in the process of closing a loan next week with a 3.375% rate. My loan officer stated to me that since my LTV is at 79% they have to charge me points. Plus my house is titled is a condo and not a single family residence.
    The points are .432% of the loan. Originally, I was told no points or origination fess besides the 3rd party fees. I wanted to know if this is a bait and switch or this is normal?
    What are your thoughts on this?
    Thanks.

  15. Colin Robertson July 18, 2016 at 10:27 am -

    Chris,

    There is a pricing hit for condos above 75% LTV…you can ask for no cost pricing as well and see what rate you wind up with. It may be something like 3.5% but with no cost and perhaps even a partial rebate for some of your closing costs.

  16. Brian July 22, 2016 at 9:25 am -

    Colin,

    I am going through a refi presently. When the initial call and paperwork was completed, my points fees were 1.875%. We thought the LTV would come in around 72%. However, when the appraisal came back much lower than expected, the LTV came out to 80%. When new paperwork was sent across my fees went up to almost double for points. When I asked why they simply said it was because of the LTV difference. Is this common practice or should I seek another lender for my refi?

  17. Colin Robertson July 22, 2016 at 3:06 pm -

    Brian,

    If you’re paying points for a given rate, say 3.75%, and your LTV rises from 72% to 80%, there may be higher pricing adjustments at the higher LTV, and thus a higher cost in points to keep that rate of 3.75%. You could ask what interest rate the original point cost would get you at 80% LTV. It might be 4% but at the original cost…

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