Calculating Loan-To-Value and LTV Explained
Loan-To-Value, or LTV, is a term used to identify the ratio between how much you owe on the loan compared to the value of the house. The Loan-To-Value is a necessary calculation when purchasing a new house or refinancing a current mortgage. Calculating this ratio gives lenders an idea as to how risky the loan will be, or how likely the homeowner is to default on the loan.
How to Calculate Loan To Value
Calculating the loan to value is not as complicated as it sounds. It is done by taking the amount of a loan you are taking out, and dividing it by the value of the home. Here is an example on how to calculate the LTV:
- Assume the Value of the home is $100,000
- You are going to put $20,000 as a down payment
- This would mean you would have to loan $80,000 from the bank in order to purchase the home.
- So the calculation would be $80,000 divided by $100,000 equals 0.80, or 80% LTV.
It’s an easy calculation that will give you a really good estimate on what percent of the home value you will need to borrow. But why is this important?
Why is the Loan To Value Ratio Important?
LTV is an important calculation when purchasing a new home or refinancing a current mortgage. This is because this value gives the lenders an idea whether or not your mortgage will be a risky mortgage or not.
High LTV means that the mortgage is at high risk of defaulting. This has negative effects on the borrower, such as:
- You are more likely to pay additional costs on top of your loan, such as mortgage insurance.
- You are more likely to have a higher interest rate associated with your mortgage loan.
- You are less likely to get approved for a mortgage loan by lenders.
Low LTV means the mortgage is not a high risk. Qualities of having a low LTV ratio are:
- Lower interest rates on the term of your home loan
- LTV of 80% or lower means you pay no insurance on the mortgage.
- Better terms and greater selection of loans for approval.
The 80% Threshold
Loan-to-Value Ratios of 80% is a benchmark for better terms when purchasing or refinancing your home. When given the option, the majority of borrowers elect to put 20% down when buying a home. This allows them to avoid mortgage insurance and higher pricing adjustments often associated with the higher risk LTVs above 80%.
Private Mortgage Insurance (PMI) is insurance the lender adds to your loan when the LTV is lower than 80%. This is to adjust the risk of lending to borrowers more likely to default on their loans. Other risk factors that can increase the PMI are income, credit score and debt amount the borrower carries. So how do you go about reaching the goal of 80% LTV?
How to Lower Your LTV
There are some easy steps to lower your LTV. This is important to lock in the lowest mortgage rate for the lifetime of the loan and avoid any additional fees. Some ideas to keep the LTV low are:
- Save. The more time you spend saving up for a home, the more money you will have as a down payment.
- Consider asking for gifts. You are allowed up to $14,000 as a tax free gift from family. This can help reach the 80% LTV and possibly pay back the $14,000 at low or no interest.
- If refinancing, wait till the property value of your home rises. You can get an appraiser to reevaluate the value of your home. If the LTV drops below 80%, the lender will consider the loan low risk and drop the PMI.
- If refinancing, you can make extra payments or a lump sum before reappraising your home.
If Your LTV is Over 100%
An underwater LTV, or loan that is more than your property value, is a tough situation to be in. This happens when the property value of a borrower depreciates, or negative amortization. This can cause problems for a homeowner who is trying to refinance their home. Primary lenders do not offer refaincing options for borrowers with underwater LTVs. However, there are some options for those who do their research.