The SCOOP! Blog by ChangeMyRate.com® Refinance or Apply for a Mortgage Online

Loan-to-Value Ratio - LTV Ratio

December 26th, 2018 7:33 AM by Jackie A. Graves

FREEHomePurchaseAnalysis             Today'sMortgageRates             FREEHomeRefinanceAnalysis

What is the Loan-to-Value Ratio - LTV Ratio

Loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more. Additionally, a loan with a high LTV ratio may require the borrower to purchase mortgage insurance to offset the risk to the lender.

How LTV Ratio Is Calculated

LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage. For example, if you buy a home appraised at \$100,000 for its appraised value and make a \$10,000 down payment, you will borrow \$90,000 resulting in an LTV ratio of 90% (90,000/100,000).

The loan-to-value ratio is a critical component of mortgage underwriting, whether it be for the purpose of buying a homerefinancing a current mortgage into a new loan or borrowing against accumulated equity within a property.

Lenders assess the LTV ratio to determine the level of exposed risk they take on when underwriting a mortgage. When borrowers request a loan for an amount that is at or near the appraised value and therefore a higher loan-to-value ratio, lenders perceive that there is a greater chance of the loan going into default because there is little to no equity built up within the property. Should foreclosure take place, the lender may find it difficult to sell the home for enough to cover the outstanding mortgage balance and make a profit from the transaction.

Factors That Impact LTV Ratio

The main factors that impact LTV ratio are down payment, sales (contract) price and appraised value. To achieve the lowest (and best) LTV ratio, raise the down payment and try to lower the sales price. Using the example above, suppose you buy a home that appraises for \$100,000 but the owner is willing to sell for \$90,000. If you make the same \$10,000 down payment, your loan is only \$80,000 resulting in an LTV ratio of 80% (80,000/100,000). If you increase your down payment to \$15,000 your mortgage loan is now \$75,000 making your LTV ratio 75% (75,000/100,000).

All of this is important because the lower the LTV ratio, the greater the chance the loan will be approved, the lower the interest rate is likely to be and the less likely you will be required to purchase private mortgage insurance (PMI).

How a High LTV Ratio Affects Your Loan

While the loan-to-value ratio is not the only determining factor in securing a mortgage, home-equity loan or line of credit, it does play a substantial role in how much borrowing costs the homeowner. In fact, a high LTV ratio can prevent you from qualifying for a loan or refinance option in the first place.

Most lenders offer mortgage and home-equity applicants the lowest possible interest rate when the loan-to-value ratio is at or below 80%. A higher LTV ratio does not exclude borrowers from being approved for a mortgage, although the total cost of the loan rises as the LTV ratio increases. A borrower with an LTV ratio of 95%, for instance, may be approved, but the interest rate may be up to a full percentage point higher than for a borrower with an LTV ratio of 75%.

In addition, if the LTV ratio is higher than 80% you will likely have to purchase private mortgage insurance (PMI) which can add anywhere from 0.5% to 1% of the entire loan amount on an annual basis. PMI of 1% on a \$100,000 loan, for example, would add \$1,000 to the amount paid per year or \$83.33 per month. PMI payments continue until the LTV ratio is 80% or lower. The LTV ratio will decrease as you pay down your loan and as the value of your home increases over time.

Requiring an 80% (or lower) LTV ratio to avoid PMI is not law but it is the practice of nearly all lenders. Exceptions are sometimes made for borrowers with high income, lower debt or other factors like a large investment portfolio.

LTV Ratio and Different Loan Types

Certain loan types have special rules when it comes to the LTV ratio.

FHA loans, which allow an initial LTV ratio of up to 96.5%, require a mortgage insurance premium (MIP) that lasts for as long as you have that loan no matter how low the LTV ratio eventually goes. Most people refinance to a conventional loan once the LTV ratio reaches 80% to eliminate the MIP.

VA and USDA loans – available to current and former military or those in rural areas, respectively – do not require private mortgage insurance even though the LTV ratio can be as high as 100%. However, both VA and USDA loans do have additional fees.

Fannie Mae’s HomeReady and Freddie Mac’s Home Possible mortgage programs for low-income borrowers allow an LTV ratio of 97% (3% down payment) but require mortgage insurance until the ratio falls to 80%.

Streamline refinance options, which waive appraisal requirements (meaning the home’s LTV ratio doesn’t affect the loan), exist for FHA, VA and USDA loans. For those with an LTV ratio over 100% – also known as being “underwater” or “upside down” – Fannie Mae’s High Loan-to-Value Refinance Option and Freddie Mac’s Enhanced Relief Refinance, which are designed to replace the HARP Refinance Program that expires Dec. 31, 2018, are available.

What Is a Good Loan-to-Value Ratio?

An LTV ratio of 80% or lower is considered good for most mortgage loan scenarios. An LTV ratio of 80% provides the best chance of being approved, the best interest rate and the greatest likelihood you will not be required to purchase mortgage insurance. As noted above, however, VA and USDA loans allow for a higher LTV ratio (up to 100%) and still avoid costly private mortgage insurance, though other fees do apply.

For most refinance options, unless you are applying for a cash-out refinance, LTV ratio doesn’t matter, so there is no such thing as “good” or “bad.” If you apply for a cash-out refinance, an LTV ratio of 90% or less is considered good.