Loan-To-Value Ratio: What It Is And How It’s Calculated
One of the critical ways lenders evaluate the risk of a mortgage for a home purchase or refinance is to look at its loan-to-value ratio. This figure compares how much you’re borrowing with the property’s value, helps determine which loan type you’re eligible for, and affects what interest rate you’ll be offered. Learn more about calculating an LTV ratio and how it affects your chances of getting a home loan.
Key Takeaways:
- The loan-to-value ratio compares the amount of money you owe on your mortgage to the value of your home.
- The lower your LTV ratio, the easier it will be to qualify for a loan.
- Some mortgage types have LTV ratio requirements that you must meet to qualify.
What Is LTV Ratio?
The loan-to-value ratio is a percentage that compares the value of the mortgage you need to buy a home and the appraised value of the home.
LTV ratios help lenders assess a borrower’s ability to afford a mortgage. The lower your LTV ratio, the less you borrow against the home’s value. This usually corresponds in reverse to the down payment: A higher down payment reduces the LTV ratio.
“When the LTV ratio is low, it means the lender is less exposed to risk, hence offering the borrower better rates and improved chances of getting the loan,” says Andy Kolodgie, Co-Founder of Property Leads, a real estate investment website based in Sheridan, Wyoming.
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How Do Mortgage Lenders Use Loan-to-Value Ratio?
Lenders use the LTV ratio in several ways.
When you first apply for a mortgage, the LTV ratio of your potential loan plays a significant role in whether you qualify and, if you do, what interest rate you will pay.
Look at it from the lender’s point of view. Imagine someone who wants to borrow $195,000 to buy something worth $200,000. They don’t have much skin in the game, so you’re taking more of a risk. If they ask to borrow $100,000, the buyer has more invested and the lender is taking on less risk and, therefore, is more likely to approve that loan.
Some loan types have maximum LTV ratios, meaning you can’t qualify if you don’t have sufficient home equity. Federal Housing Administration loans set a maximum LTV of 96.5%, meaning you need a down payment of at least 3.5% of the home’s value.
LTV Ratio And Private Mortgage Insurance
Private mortgage insurance is a policy that reimburses your lender if you default on your loan. Many loan types and lenders require borrowers to pay for PMI if their LTV ratio exceeds a specific amount.
For conventional loans, you typically have to pay for PMI if your LTV ratio is more than 80%, meaning you’ve made a down payment of less than 20% of the home’s value. Your LTV ratio will decrease as you pay down your mortgage balance and if your home’s value appreciates. Most lenders will cancel PMI when your LTV drops to 78% or at the midpoint of your loan’s repayment schedule.
Keep in mind that your lender will calculate the LTV ratio using the most recent appraised value of your home. If you believe your home has increased in value, you can request – and usually must pay for – a new appraisal.
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What Is A Good Loan-To-Value Ratio?
An LTV ratio of 80% or less is a good target to aim for. Lenders will offer you lower interest rates, and you can avoid PMI on a loan with an 80% LTV ratio.
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How To Calculate Loan-To-Value Ratio
LTV ratios are easy to calculate: Divide your loan balance by the appraised value of your property and multiply the result by 100 to get a percentage.
For example, if a lender gives you a $380,000 loan on a home appraised at $400,000, you’ll divide $380,000 by $400,000 and multiply by 100 to get an LTV ratio of 95%.
Loan-To-Value Ratio Vs. Combined Loan-to-Value Ratio
Some borrowers have more than one mortgage secured by their home, such as a home equity loan or home equity line of credit.
A combined loan-to-value ratio, or CLTV ratio, considers the balance of all loans secured by your home.
Let’s say you own a home worth $400,000 and have a mortgage with a balance of $200,000 and a HELOC with a balance of $50,000. Your primary mortgage’s LTV ratio is 50%, and the HELOC’s LTV ratio is 12.5%. The total debt is $250,000, which results in a CLTV ratio of 62.5%.
Loan-To-Value Ratio By Loan Type
Different loan types require different LTV ratios. Generally, the less risk a lender faces, the higher the borrower’s LTV ratio can be.
Conventional loans, which aren’t insured by the government, require a lower LTV ratio unless you have an excellent credit score. Government loan programs, such as the FHA, U.S. Department of Agriculture and Veterans Affairs loan programs, are insured, allowing lenders to take greater risks and approve loans with a higher LTV ratio.
Maximum LTV Ratio By Loan Type Header
| Loan Type | Maximum LTV Ratio |
|---|---|
| Conventional Conforming Loan | 97% |
| Jumbo or Nonconforming Loan | Varies by lender, often 80% or lower |
| FHA Loan | 96.5% |
| VA Loan | 100% |
| USDA Loan | Greater than 100% as the guarantee fee can be financed in addition to 100% of the home’s value |
| Refinance | 95% |
| Cash-Out Refinance | 80% |
Tips For Lowering Your LTV Ratio
Lowering your LTV ratio can help you qualify for a better rate and avoid PMI payments. Here are some tips for reducing your LTV ratio quickly, whether you’re buying a new home or refinancing.
How To Improve Your LTV Ratio For A New Home
If you’re buying a new home, here are some ways you can improve your loan-to-value ratio:
- Make a larger down payment. The bigger your down payment, the less you’ll have to borrow from your lender, resulting in a lower LTV ratio.
- Choose a less expensive home. Imagine you have $20,000 for a down payment on a home. The less expensive the home, the further that money will go when reducing your LTV ratio. If you buy a $400,000 home, you’d need to borrow $380,000, giving you an LTV ratio of 95%. But if you found a $200,000 home, you’d only have to borrow $180,000, and your LTV ratio would decrease to 90%.
- Piggyback loans. Some lenders will let you apply for piggyback loans, which are additional mortgages – usually a home equity loan or HELOC – in addition to your primary loan. Often, these are used to finance a down payment, letting you avoid PMI. Because the LTV ratio only looks at the balance of your primary mortgage, piggyback loans will reduce your LTV ratio. However, they do count toward your CLTV ratio.
- Choose a shorter loan term. This won’t reduce your LTV ratio immediately, but if you choose a loan with a shorter term, you’ll reduce your LTV ratio faster. Shorter terms lead to larger monthly loan payments and a faster reduction in loan principal, speeding up the process of building equity and lowering your loan’s LTV ratio.
How To Improve Your Loan-To-Value Ratio For Refinancing
Even if you already own a home, improving your LTV ratio is a worthwhile goal if you’re planning to refinance. A lower LTV ratio can lead to lower monthly payments.
A few ways to reduce your LTV ratio before refinancing include:
- Making regular mortgage payments. Payingyour mortgage on time lowers your principal and builds equity. The further you get in your repayment schedule, the more quickly your LTV ratio will fall as more of each payment goes toward the principal.
- Boost your home’s value. If your home gains value, your LTV ratio will fall even if your loan balance stays unchanged. If you put in some legwork to improve your home’s curb appeal or utility, you can increase its value. If you’re a savvy DIYer, there are plenty of ways to build sweat equity in your home before it’s appraised by a professional.
- Wait for the real estate market to shift. Home values tend to rise over time. If you wait, your home could gain value and reduce your LTV ratio. Of course, there’s always a risk that values will drop, so before you refinance your mortgage, use the Federal Housing Finance Agency’s House Price Calculator to see how homes in your area have appreciated in value.
The Bottom Line
Remember, your LTV ratio is only one part of your mortgage application. That being said, the lower your LTV ratio is, the lower your interest rate is and the more likely you are to avoid PMI payments. Understanding your LTV ratio can help determine whether you’re ready for a mortgage and clarify which home loans are available.
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