To calculate loan-to-value you take the total amount of your loan divided by the value of the home you are going to buy.
A home’s loan-to-value ratio (aka LTV) is the percentage of the home that is going to be financed. To calculate loan-to-value you take the total amount of your loan divided by the value of the home you are going to buy.
- If x = the home’s value,
- and y = your mortgage,
- then x / y = LTV percentage
What’s left? Your down payment.
The math is pretty basic, but this little equation’s importance when buying a home is slightly more complex.
Why Is LTV Important?
The LTV ratio is a very significant factor when buying a home. Whether your ratio is high or low will determine the risk of the loan you apply for, the interest rate, fees you will pay with your loan, and whether or not you will have to pay for private mortgage insurance.
How Is The Home’s Value Determined?
The value of a home comes from either its appraised value or market value. Whichever value is lower at the time will be used as the home’s official value and then calculated into the LTV. At first the appraised value will most likely be an estimated number. Later on it will be approved by a professional appraiser and adjusted if necessary in the final stages of the loan process. If the market value (what you will actually pay for the home) is lower than the appraised value, the market value will be used instead.
What Is Considered A High LTV?
An LTV above 80 percent is usually considered high. This means that you will be putting less than 20 percent down on the property, resulting in a higher LTV. A higher LTV signifies a greater risk and typically comes with a larger interest rate. An LTV above 100 percent means that you would be borrowing more money than the property is actually worth. Sounds like a bad move? It can be, and it was these types of risky loans that helped ignite the latest mortgage crisis. In today’s market, lenders are more cautious granting loans with high LTV ratios. However, some exceptions are made for
borrowers with outstanding credit scores or impeccable borrowing history.
So The Lower The Better?
In the eyes of a lender, the lower the LTV ratio, the lower the risk. Home buyers with an LTV below 80 percent are considered to be taking a low risk loan and therefore will be offered that loan at a lower interest rate. Obviously the LTV ratio is not the only thing a lender takes into consideration, your credit score plays a factor as well, but having a low LTV works to your advantage.
Why do I have to pay for Private Mortgage Insurance?
Private mortgage insurance, or PMI, protects the lender from loan default. If your LTV is over 80 percent you may be required to pay for PMI. However, once your payments on your principal bring you to an LTV ratio of 80 percent, you will most likely be able to cancel your PMI. In some cases with high-risk borrowers, a lender may require PMI be paid for a longer period of time until a lower LTV ratio is reached.
Does Everyone With An LTV Over 80% Have To Pay PMI?
Since many buyers can’t afford to put 20 percent or more down on a home, Private mortgage insurance is not uncommon, but avoidable in some circumstances. If your LTV ratio is over 80 percent, but you’d prefer to not pay for PMI, some lenders will negotiate a higher interest rate as an alternative.
An “80-10-10” loan is another option for those who can only put a 10 percent down payment on a property. Basically, you take two loans, which combined equal 90 percent, but separately are 80 percent and 10 percent. This allows you to avoid paying PMI with an LTV ratio over 80 percent and brings you to a monthly payment that is less than paying for a mortgage plus private mortgage insurance.
How Can I Lower My LTV Ratio?
The only way to lower your LTV ratio is to either find a home with a lower property value or put down a larger down payment. Aside from these two options, there are no other ways to lower an LTV ratio since it is solely dependent on the value of the home and the amount of money you need to borrow.