Loan-to-Value Ratio (LTV): What Is It & How to Calculate It | BiggerPockets Blog

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The loan-to-value (LTV) ratio is a key metric that mortgage lenders use to assess the risk of lending them money. Most lenders use the LTV ratio, credit score, debt-to-income ratio, interest rate, and property value when processing your mortgage application. The loan-to-value ratio affects the amount of down payment required by the lender.

Simply put – the lower your LTV ratio, the better your chance of getting approved financing at a competitive rate.

This article is a complete guide to understanding LTV ratios and how they can help you make wise real estate investments. You will also learn how to calculate LTV ratios. In addition, you will get key insights into securing cheaper financing terms.

What is the LTV (Loan-to-Value) Ratio in Real Estate Investing?

The loan-to-value ratio is the difference between the appraised value of the property and the loan amount you want to borrow. LTV is expressed as a percentage and helps lenders determine your eligibility for a loan. This number is used as a percentage of all conventional loans, home loans, FHA loans, and auto loans.

LTV compares the amount of the mortgage loan to the value of the home, or equity. In the eyes of lenders, a higher LTV ratio means that the risk of default is greater. Therefore, the lender may increase mortgage costs, such as down payment size and interest rates. On the other hand, a lower LTV increases your chances of getting favorable loan terms. Lenders have more confidence that you will make your monthly mortgage payments.

Understand the loan-to-value ratio

Calculating the LTV ratio is essential to the mortgage loan application process. Lenders use it to set the terms for purchasing a property, refinancing an existing home loan, or approving a home loan. Lenders view you as a greater risk if you apply for a loan close to the market value of the property.

Money lenders use the loan-to-value ratio to reduce the risk of losing money in the event of default. For example, in the case of a foreclosure, the lender may not be able to sell the home at a price that covers the outstanding mortgage balance.

The three basic factors affecting LTV ratios are as follows:

• Estimated property value
• Advance payment amount
• selling price

What is a good LTV value?

The ideal maximum loan ratio when applying for a mortgage or home equity loan is 80% or less. Therefore, the down payment will be 20% of the purchase price. When you have a good LTV, you can expect the lenders to offer you the lowest interest rate. You can also avoid paying private mortgage insurance — which can save thousands of dollars over the life of the loan.

How to calculate permanent value

The LTV ratio is easy to calculate by dividing the loan amount by the value of the asset you are borrowing against. For a mortgage, this means dividing the amount of the mortgage by the value of the property. To get a percentage number, you multiply the result by 100.

This is the formula for calculating LTV:

([Total loan amount] ÷ [property’s appraised value]) x 100 = LTV ratio

For example, suppose you plan to invest in a property worth $230,000, and you have $60,000 for a down payment. Therefore, the total mortgage amount is $170,000. This means that your LTV will be 74%. Here is the LTV account:

$170,000 = $230,000 = 0.74

0.74 x 100 = 74%

Looking at the calculation, you can see that you can lower your borrowing amount and make a lower LTV percentage by paying a larger down payment.

It is important to note the difference between the purchase price and the estimated property value. Lenders usually rate LTV based on their rating. However, your LTV will be based on the appraised value or purchase price, whichever is lower.

How Lenders Use LTV Ratios

The loan-to-value ratio is one of the metrics that lenders use when evaluating mortgage loan applications. Other factors that can affect loan eligibility include credit score, DTI, employment history, property value, and down payment. However, the LTV ratio will greatly affect borrowing costs in relation to higher mortgage rates.

Although the minimum ideal mortgage is generally 80%, you can secure a mortgage with a higher rate than an LTV. However, you will face higher borrowing costs. higher interest rates and Private mortgage insurance There are two ways that a higher LTV ratio can affect your total mortgage amount.

Let’s see how these factors affect the amount you have to pay back.

• Requiring Private Mortgage Insurance (PMI): An LTV of more than 80% may mean that you must purchase private mortgage insurance. Depending on the product, this can add between 0.5% and 1.0% to the total loan amount annually. However, payments are usually necessary until the LTV is less than 80%.
• Higher interest rates: LTV affects mortgage rates. Lenders usually charge higher rates of interest on a prime mortgage with a high LTV. In some cases, this whole percentage may be higher than a borrower with a lower LTV.

It is good to note that if you have to buy your own mortgage insurance, you can have closing costs and PMI cost added to your monthly mortgage payments.

Depending on other factors, the mortgage lender may use the loan-to-value ratio to decide that you do not qualify for a conventional home equity loan. These factors can include your credit history, insufficient income, or a high DTI.

How do lenders rate LTV and DTI ratios?

Apart from the LTV ratio, debt-to-income ratio It is another vital factor used by the lenders while applying for a home loan. Lenders must be satisfied that you can pay off the home loan monthly. To do this, they evaluate the front-end ratio and the back-end ratio.

• front end ratio: This number is part of the total monthly income that you spend on housing expenses. They include mortgage payments, taxes, homeowners insurance, and other housing-related expenses.
• rear end ratio: This number is the percentage of your income to cover all of your debt obligations. This can include your car loan, credit card debt, and other debts that appear on your credit report.

Why is the LTV ratio important to real estate investors?

The LTV ratio is an important real estate metric that investors should understand. It helps you know when and how you can get affordable financing for smart real estate investments. However, it also helps you assess the relative strength of your position in the market. Therefore, the LTV ratio can help you make key decisions when buying, selling or refinancing a property.

For example, understanding LTV is helpful when deciding to sell or refinance a real estate asset. A low LTV ratio clearly indicates that the property has a lot of equity. Therefore, you may want to redirect some of those shares into new investments. This means that you can come to the table with a higher down payment, thus lowering the LTV percentage for your next loan.

What is a Compound Loan to Value (CLTV)?

A combined loan-to-value (CLTV) ratio considers second mortgages as home equity lines of credit (HELOCs) and home equity loans and other concessions. Therefore, if you are applying for a second loan, you must calculate the combined loan-to-value ratio.

LTV and CLTV depend on how much equity you have in the home compared to the total amount you want to borrow.

To calculate the combined LTV percentage, you add the current loan balance on your home to the amount you want to borrow. Then you divide the amount by the appraised value of your home. Next, multiply the result by 100 to find out the CLTV percentage.

How to lower your LTV

There are two main ways to reduce a loan to value (LTV) loan. First, reduce the amount you have to borrow. Second, look for a property of lower value or offer to buy the home at a lower price. This way, you can secure a lower monthly payment.

Make a larger down payment

The best way to reduce your LTV percentage is to save up for a larger down payment—ideally, at least 20%. In this way, you lower your LTV amount because you are borrowing less money. Ideally, it would be best to borrow no more than 80% of the appraised value of the home.

Find a cheaper property

You can lower your LTV by looking for an affordable property. Because you’re borrowing less, your ELA will decrease accordingly, provided you can still make the 20% down payment. You can optimize your borrowing costs by lowering the borrowing amount and negotiating a better selling price.

Loan-to-value rules for different types of mortgage

While 80% may be the standard loan-to-value (LTV) ratio when applying for a conventional loan, the requirements depend on the mortgage program. Below are the loan requirements by type of loan.

conventional mortgages

A typical mortgage requires an LTV of at least 80%. The best mortgage lenders may have additional requirements for higher rate mortgages.

Mortgage refinance loan

Getting the best mortgage rates when you refinance a loan requires a lethal value ratio of at least 80%. Therefore, if you are refinancing your mortgage based on your home equity or have multiple loans, you must calculate the combined LTV percentage.

FHA loans

Home loans backed by the Federal Housing Administration have less stringent requirements. A home buyer can usually qualify for an FHA loan with high LTV percentages — sometimes as high as 96.5%. However, having mortgage insurance on FHA loans is a requirement, regardless of the size of the down payment.

VA loans

Government-backed mortgages like VA loans require no down payment. If the home buyer meets the requirements, they can qualify for a 100% mortgage. Aside from the VA appraisal fee, they must also pay additional costs on this type of loan, such as closing costs.

USDA loans

The USDA Loan Program allows rural buyers to obtain a home loan without a down payment. Therefore, LTV can reach 100%.

Fannie Mae and Freddie Mac loans

Government-backed mortgages such as Freddie Mac and Fannie Mae allow potential homeowners to secure a 97% mortgage. However, these loans require mortgage insurance for the LTV to drop to 80% or less. In addition, home buyers must meet credit rating requirements.

LTV ratio – in conclusion

The loan-to-value (LTV) ratio is an important metric in real estate investing. The number measures the estimated market value of the home you want to buy compared to how much you need to borrow. The LTV ratio helps lenders assess your borrowing risk.

Getting the maximum allowable ratio down as low as possible generally leads to lower mortgage costs. With a percentage rate of up to 80%, lenders can offer better interest rates, waive the need for mortgage insurance, and offer you better borrowing deals.

Note by BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.