If you are looking to purchase residential or commercial real estate, you will want to know your LTV ratio.
LTV stands for loan-to-value ratio. Lenders use the loan-to-value ratio to calculate how much risk they are assuming when lending you money for a mortgage.
The loan-to-value ratio measures the amount of the money you need to borrow against the market value of the asset.
A lower LTV shows that there is less risk for the lender to provide the funds to the borrower. A higher LTV indicates more risk for the lender because there is less money up front. A low LTV ratio would be anything equal to or less than 80%. A high LTV would be 95% or greater.
Any type of lender can evaluate risk by calculating the loan-to-value ratio but it’s most commonly used for real estate and mortgage loans. Some lenders require a certain LTV percentage to qualify for a loan.
Loan-to-value ratio affects your interest rate, amount owed, and your ability to qualify for a home loan. Let’s calculate your LTV to find out how much risk the lender will take on if they work with you.
How to Calculate Your Loan-to-Value Ratio
Calculating your loan-to-value ratio is easy. All you need is to know how much money you still owe on your loan, how much you have paid off, and some math skills.
To calculate your LTV ratio, divide the amount of the loan by the appraised value of the asset securing the loan.
Loan amount / Appraised value of the asset = Loan-to-Value
The amount of money you put down is what alters your loan-to-value ratio. The greater the down payment you put down the lower your LTV ratio will be. And vice versa; the lower the down payment, the higher your LTV ratio will be.
For example, let’s say you’re seeking out a loan of $200,000 for a new home. You want to avoid paying PMI so you put 20% down, which is $40,000. Therefore, you only need to borrow $160,000.
To calculate your LTV ratio you would divide the amount borrowed: $160,000 by the appraised value of the asset: $200,000. This would give you a LTV ratio of 80%.
$160,000 / $200,000 = 80%.
This is a strong LTV ratio. Lenders like to see LTV ratios of 80% or less. If you can achieve this ratio, you will have a much easier time getting a loan.
Realistically, most homebuyers cannot afford a $40,000 down payment on a home. Many potential property owners eat the cost of PMI and only put down 5 to 10%. Let’s say you put a minimum down payment of 5% on a $200,000 loan for a total of $10,000. Your LTV ratio would be 95%.
$190,000 / $200,000 = 95%
Remember that lenders want to see a lower LTV ratio because it’s less risky. The more risk the lender endures the more interest they will tack on to your loan to help lower that risk. Although this LTV ratio is fairly high, you can still qualify for a mortgage with a 95% ratio.
How Your Loan-to-Value Ratio Affects Your Loan Options
As we talked about earlier, lenders use the loan-to-value ratio to access risk. Depending on what your LTV ratio is, you may not qualify for different types of loans or interest rates. Our experts highlighted the 3 most popular home loans to show you how your loan-to-value ratio affects your loan options.
Conventional Loans
Conventional loans are loans that are backed by private mortgage lenders. They follow the lending guidelines set by Fannie Mae and Freddie Mac. Borrowers can obtain a conventional loan with a LTV of 97% or higher. If you want to avoid paying PMI (private mortgage insurance) you will need to have a LTV of 80% or lower.
FHA Loans
FHA loans are mortgage loans backed by the Federal Housing Administration. These home loans are more flexible than conventional loans, requiring a lower minimum down payment and lower credit scores. You can qualify for an FHA loan with an LTV as high at 96.5%, that’s only 3.5% down!
VA Loans
VA loans are by far the most borrower friendly mortgage loans you can get. However, not everyone will qualify for a VA loan. To qualify you need to be a veteran. VA loans don’t require a down payment allowing borrowers to get approved for a loan with an LTV ratio of 100% (borrowing 100% of the asset’s value).
2 Simple Ways to Lower Your Loan-to-Value Ratio
There are a few different ways borrowers can lower their LTV ratio; however there are 2 that are much more popular than alternative methods.
The 2 most common ways to lower your LTV ratio is by:
- Putting down a larger down payment
- Buying a lower priced home.
Both ways involve reducing the amount of money you need to borrow.
Putting down a larger down payment lowers your LTV ratio by reducing the amount of money you need to borrow. Paying more upfront can eliminate the need for private mortgage insurance (PMI) and even lower the interest rate over the life of the loan.
Buying a lower priced home lowers your LTV ratio by reducing the price of the asset’s value. If you find a more affordable home, you will be able to pay a larger percentage for a down payment which in turn, lowers your LTV.
What is the Difference Between LTV and CLTV
Loan-to-value ratios and combined loan-to-value ratios are very similar but there is one key difference between the two types of ratios. LTV is the ratio of one mortgage balance compared to the home’s value.
CLTV combines multiple mortgages and loans together. If you own more than one property lenders will start to look at your combined loan-to-value ratio by grouping all of your loans and asset values into one ratio.
Although both ratios are important, CLTV have higher limits compared to LTV because there is more collateral in the deal.
Why Your Loan-to-Value Ratio is Important
LTV ratios are important for both borrowers and lenders. Lenders use them as a key metric to measure the risk they are taking on by lending you money. LTV is important for buyers because without a good LTV ratio, you may not qualify or get approved for a mortgage loan.
If you are thinking of buying a property you should calculate your LTV to get an idea of what loans you will qualify for and what your payments will be.
There are LTV calculators out there if you aren’t confident in your math skills but usually your cell phone’s calculator will be able to get the job done.
If you want more insights about loan-to-value ratios and how to lower your percentage, we can help! At Yieldi, we specialize in getting you the funds you need to buy a home or investment property.
Get in touch with our team today for a free consultation!
