What is Loan to Value?
Monday mortgage Q&A: “What is loan to value?”
You’ve probably heard the phrase loan-to-value get thrown around a lot lately, what with all the stories of negative equity and underwater borrowers.
Put simply, loan-to-value, or “LTV,” is the loan amount divided by the appraised value of the property.
Let’s look at an example:
Property Value: $500,000
Loan Amount: $350,000
Loan to Value (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 equity, or ownership, in the property.
Essentially, the lower the loan-to-value, the better, as it means you have more ownership in the property.
Not only that, but banks and mortgage lenders also set up pricing adjustment tiers based on loan-to-value.
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 increases (higher LTV = greater risk).
So if your mortgage rate is bumped a quarter of a percent for a loan-to-value of 70 percent, that hit may be increased to a half a percent if the loan-to-value 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/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, or CLTV, would be 80 percent.
Simple math: $350,000 + $50,000 = $400,000 / $500,000 = 80%
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 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 example:
Property Value: $400,000
Loan Amount: $500,000
Loan to Value (LTV): 125%
The problem with these borrowers is that they have little incentive to stick around, even with a modified 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 the property value increases, the LTV will fall.
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