A loan-to-value ratio is a finance term that calculates the ratio between your mortgage and the home’s appraised value. The higher the ratio, the higher the risk is on the loan. A high ratio is when the value of the assets on the loan is equal to or less than the loan itself.
As a result, a lower loan-to-value ratio is more attractive because these borrowers have more equity in their homes. If the borrower defaults, the lender will have an easier time selling the house in foreclosure to cover the remaining loan balance and still get their profit.
This rate is used for approving loans, assessing mortgage insurance requirements, refinancing and can even influence your interest rate.
Your LTV ratio is calculated by dividing the loan amount by the appraised value of the property. For example, let’s say you buy a home with an appraised value of $100,000. You put down a $20,000 down payment. As a result, you will need to borrow $100,000 minus $20,000, or $80,000. Your LTV ratio is 80% ($80,000 / $100,000).
Lenders have a threshold for what is an acceptable LTV ratio. This amount varies depending on the type of loan. For example, the maximum LTV ratio for a conventional mortgage is usually 97% whereas the maximum for an FHA loan is 96.5%.
On the other hand, USDA and VA loans allow homebuyers to purchase a home with 0% down. As a result, these borrowers have an LTV ratio of 100%.
Lenders will evaluate your LTV during the loan approval process. Borrowers with lower LTV ratios usually qualify for lower mortgage interest rates.
If your LTV is higher than 80%, lenders will likely require you to purchase private mortgage insurance or PMI. PMI will typically stay on your mortgage payment until the LTV ratio is 80% or lower. To avoid this extra expense, you will need to have a minimum 20% downpayment.
Having an LTV ratio of over 100% is possible. Borrowers who are “upside-down” or “underwater” on their mortgage. In other words, the value of their home is less than their loan amount and results in negative equity. This happens when the house loses value after you buy it.
Let’s say that you purchased a $300,000 home. However, because of the market, your home is now worth $250,000. Unfortunately, you still owe $300,000. Your LTV ratio is $300,000 divided by $250,000, or 120%. If you decided to sell your house for $250,000, you would need to pay the $50,000 difference.
For borrowers in this situation with extremely high LTV ratios, there are refinance programs available, such as the Home Affordable Refinance Program or HARP.