January 20th, 2019 10:53 AM by Jackie A. Graves
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.
Home buyers can easily calculate the loan-to-value
ratio on their home by dividing the total mortgage loan amount into the
total purchase price of the home. For instance, a home with a purchase price of
$200,000 and a total mortgage loan for $180,000 results in a loan-to-value
ratio of 90%. Conventional mortgage lenders often provide better loan terms to
borrowers who have loan-to-value ratios no higher than 80%.
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%
The loan-to-value ratio is a critical component of mortgage underwriting,
whether it be for the purpose of buying
a home, refinancing 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 defaultbecause
there is little to no equity built up within the property. Should foreclosuretake
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.
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).
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).
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.
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
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.
loan-to-value ratio is the largest allowable ratio of a loan's
size to the dollar value of the property. The higher the loan to value ratio,
the bigger the portion of the purchase price that was financed. Since the home
is collateral for
the loan, the loan-to-value ratio is a measure of risk used by
lenders. Different loan programs are viewed to have different risk factors, and
therefore, have different maximum loan-to-value ratios.
Certain loan types have special rules when it comes to the LTV
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.
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
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%.
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.
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.
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.
While the LTV ratio looks at the impact of a single mortgage
loan when purchasing a property, the combined loan-to-value (CLTV) ratio is the
ratio of all secured
loans on a property to the value of a property. Lenders use the CLTV ratio
to determine a prospective home buyer's risk of default when more than one loan
is used - for instance if they will have two or more mortgages, or a mortgage
plus a home equity loan or line of credit (HELOC). In general, lenders are
willing to lend at CLTV ratios of 80% and above to borrowers with high credit
ratio considers only the primary mortgage balance. Therefore, in the above
example, the LTV ratio is 50%, the result of dividing the primary mortgage
balance of $100,000 by the home value of $200,000. Primary lenders tend to be
more generous with CLTV requirements. Considering the example above, in the
event of a foreclosure, the primary mortgage holder receives its money in full
before the second mortgage holder receives anything. If the property value decreases
to $125,000 before the borrower defaults, the primary lien-holder receives the
entire amount owed ($100,000), while the second lien-holder only receives the
remaining $25,000 despite being owed $50,000. The primary lien-holder shoulders
less risk in the case of declining property values and therefore can afford to
lend at a higher CLTV.
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