Whether you’re taking out a new mortgage loan or refinancing an existing loan, your home’s loan-to-value, or LTV, ratio will come into play. But what is LTV on a mortgage? This ratio compares your loan amount to what your home is actually worth, based on its current market value.
Understanding how LTV is calculated, why it matters to lenders, and how it can impact both the terms and rates on your home loan is key to prepare you for the mortgage approval process.
What is loan-to-value ratio and how do I calculate it?
Your home’s loan-to-value (LTV) ratio is an important tool when determining how much of your home’s value you actually own, compared to what you owe to your lender.
So, what is LTV as far as you and your lender are concerned? This formula takes into account the property’s appraisal amount versus loan amount. The result of that formula can tell you how much equity you hold in the property and what percentage is owned by the lender.
Your LTV ratio can be reduced over time as you make payments toward your loan’s principal balance. The larger your down payment when buying the home, the lower your LTV ratio will be from the outset. Additionally, your LTV ratio can fall if your home’s appraised value goes up due to market fluctuations or other factors impacting its worth.
How to calculate loan to value (LTV) ratios
Calculating your home’s LTV ratio is actually very simple. The loan-to-value ratio formula is just your remaining loan balance divided by the property’s appraised value.
Loan amount / Value [what your property is worth] = LTV
To express this ratio as a percentage, simply multiply the result by 100. For instance, if you owe $200,000 on your home, which is appraised at a value of $500,000, your LTV ratio is 40%.
200,000 / 500,000 = 0.4
0.4 x 100 = 40%
In essence, this means that you have 60% equity in your home, while your lender holds the remaining 40%.
Most lenders will set LTV maximums when it comes to approving a first mortgage loan, or even refinancing a mortgage. If you have an LTV ratio higher than 80%, you’ll typically have to pay private mortgage insurance (PMI) on your loan until your LTV falls below this threshold.
How your LTV ratio impacts mortgage and refinance rates
Generally, lenders prefer to take on as little risk as possible. When they do approve a higher-risk loan, it often comes with higher interest rates to offset the potential financial loss if you fail to repay the mortgage. This is often the case with high real estate LTV ratios. But what does loan-to-value mean to lenders in the first place?
The higher the difference between the home’s value and the amount being financed through a mortgage loan, the less of a risk it poses to the lender. If the buyer were to default on the loan, for instance, the lender has a better chance of recouping its investment if there’s a fair amount of equity built into the property.
If a lender is willing to approve a riskier loan-to-value mortgage, you’ll typically be charged a higher interest rate. Additionally, you may encounter more limited loan term options and even a PMI requirement, when compared to a lower-LTV loan application. This is similar to applying for a mortgage loan with a low credit score, for instance, or a high debt-to-income ratio.
While many conventional mortgage lenders are willing to offer mortgage loans with LTVs higher than 80% (typically with the aforementioned PMI charge), loan-to-value refinance rules may be more stringent. Generally, you should expect lenders to require an 80% loan-to-value ratio, if not lower, for refinances. Some lenders are willing to refinance with a higher LTV, but borrowers should still expect to pay higher interest rates and/or PMI for the loan.
Home equity loan borrowers should also be aware of loan-to-value ratio limitations. Home equity loan LTV requirements are often even stricter than original mortgage and refi requirements. That’s because the borrower is essentially taking out a loan against the home’s equity. For this reason, lenders generally only let borrowers access a portion of this equity, usually up to a maximum of 80%.
For example: You owe $300,000 on a $400,000 home. This puts your LTV at 75%, meaning that you own 25% of the home’s equity. Since most lenders will only offer home equity loans up to 80% LTV, you will probably only be able to take out a loan for up to $20,000. This represents 5% of your home’s value, bringing your new LTV ratio up to 80%.
What LTV ratio means for your loan
Whether you have a high or low LTV on your home, you can expect it to impact your mortgage loan in several ways.
Some key characteristics of your loan that are affected by LTV include:
- Loan acceptance or rejection: A high LTV on your home can result in your loan application being rejected if it exceeds the lender’s limits or, if combined with your other personal factors such as income and credit score, the loan appears too risky to the lender. Conversely, a lower LTV may boost chances of loan application acceptance.
- PMI: Expect that if your LTV is higher than 80% on an original mortgage or refinance loan, you will be required to pay for private mortgage insurance, or PMI.
- How much house you can afford: Your mortgage lender will consider LTV when determining which loan terms and interest rate to offer you. If you’re given a higher rate as a result of a higher LTV (which may also include PMI), your mortgage loan will suddenly be more expensive each month. These factors can affect how much home you can afford, as you may need to look for a less expensive property to account for higher rates and added fees.
What is a good LTV ratio for a mortgage?
So, what is a good loan-to-value ratio to aim for when it comes to improving your mortgage interest rate? In general, anything less than 80% will help you improve your rate and avoid PMI; however, factors such as your income, credit history, and existing debt burden will also factor in. An LTV lower than 80% is considered “good” and means that you own a fair share of your home’s equity.
Additionally, there are different maximum loan-to-value ratio limits and requirements depending on the type of loan you choose and whether you qualify for a mortgage with a low down payment.
|Conventional loans||FHA loans||USDA loans||VA loans|
|Maximum loan-to-value ratio||80% preferred, but some lenders may allow higher LTVs||96.5%||100%||100%|
When it comes to buying or refinancing a home, your LTV ratio matters. Not only can this ratio impact your loan application, but a high LTV can result in limited loan terms, higher interest rates, and trigger PMI requirements — all of which might cost you more in the end.
If you’re unable to qualify for a loan due to a property’s LTV, you may need to make a larger down payment. You may also be able to increase your chances of qualifying by adding a creditworthy co-borrower to your loan. If you already own a home, continuing to make payments to the principal balance will help to reduce your LTV ratio, as will an increase in the property’s market value over time.
Want to learn more about your mortgage options? Talk to a local Finance of America Mortgage Advisor today.