When you apply for a mortgage or another type of loan, the lender will want to assess a number of important factors before determining whether or not to approve your loan application. One of these factors is your loan-to-value ratio (LTV).
But what exactly is an LTV, and why does it matter when it comes to applying for a loan?
What Is A Loan-To-Value Ratio (LTV)?
A loan-to-value ratio essentially measures the loan amount against the value of the asset being purchased with the loan. The loan balance is divided by the value of the asset to calculate the loan-to-value ratio.
A higher LTV ratio means that you need a higher loan amount to pay for the purchase of the asset. Over time, your LTV will decrease as you continue making loan payments and as the asset’s value appreciates.
How To Calculate Your Loan-To-Value Ratio?
As mentioned above, the loan-to-value ratio formula is the loan amount divided by the asset value. For example, let’s say you’re buying a home that’s worth $500,000 and need to take out a loan of $400,000 to finance the purchase.
In this case, your loan amount is $400,000 and the value of the asset is $500,000. Using the calculation described above, your loan-to-value ratio would be 80% ($400,000 divided by $500,000).
|Down Payment||20% ($100,000)|
|Calculation||$400,000/$500,000 = 0.8|
Why Are Loan-to-Value Ratios So Important?
Lenders use LTVs to determine how large of a loan you require relative to what the asset that you need to finance is actually worth. It’s a measure of risk, as higher LTVs are considered riskier than lower ones. That’s because a higher LTV ratio means that a larger portion of the asset in question is being financed with the loan.
Why Do Lenders Prefer Lower LTV Ratios?
The more money you owe relative to the value of the asset, the more of a risk you would be considered in the eyes of the lender. Higher LTVs mean that the borrower is providing less of their own money as a down payment to buy the asset in question, and therefore is at a higher risk of defaulting on the loan.
In order to minimize risk, lenders generally prefer working with lower LTV ratios. However, some lenders may still work with higher LTVs, but they may charge higher interest rates to lower their risk.
How Do LTV Ratios Affect Mortgage Default Insurance?
Your loan-to-value (LTV) ratio will determine how much you will have to pay for mortgage default insurance. The higher your LTV, the higher the risk you will be in the eyes of your lender.
Mortgage default insurance is designed to protect the lender in case you default on your home loan and is required if you make a down payment of less than 20% of the home’s purchase price. This type of insurance allows borrowers to qualify for a mortgage with a down payment of as little as 5%.
How Much Mortgage Default Insurance Will You Have To Pay?
The exact premium you’ll need to pay depends on your LTV ratio. Generally speaking, the higher your LTV, the more expensive your mortgage default insurance premiums will be.
The following chart outlines the current costs of mortgage default insurance as determined by your LTV:
|LTV Ratio||Insurance Premium Cost on the Loan|
|Up to and including 65%||0.60%|
|Up to and including 75%||1.70%|
|Up to and including 80%||2.40%|
|Up to and including 85%||2.80%|
|Up to and including 90%||3.10%|
|Up to and including 95%||4.00%|
How Do Higher LTV Ratios Affect Your Loan Payments?
An LTV also dictates how much you are responsible for paying on your regular payments. A higher LTV means that your loan amount will also be higher, which means you’ll have a bigger payment to make every billing period.
The lower the LTV, the lower the loan amount taken relative to the purchase price of your home. In this case, you’ll have less to pay in order to repay your loan in full.
What Is A Good Loan-To-Value Ratio For Refinancing?
The key to refinancing is your loan-to-value ratio. When determining if you qualify for a refinance, your loan-to-value ratio is a crucial metric that your lender will use. Not only will your LTV help assess whether or not you are eligible to refinance, but it will also help your lender choose your terms, interest rate, and other factors associated with your loan.
You will typically need a specific LTV in order to qualify for a refinance. Generally speaking, most lenders will require that borrowers have at least 20% equity in their home in order to be eligible for a conventional refinance. That means your LTV should be no higher than 80%.
That said, some lenders may accept higher LTVs for a refinance, although other aspects of a borrower’s financial profile must be quite healthy for this. Further, a higher LTV will usually mean a higher interest rate.
What LTV ratio do you need to refinance?
What is the maximum LTV ratio for a HELOC?
What is a high-ratio mortgage?
What are low-ratio mortgages?
Looking To Apply For A Loan?
Whether you’re applying for a mortgage, car loan, or any other similar type of loan that typically requires some form of down payment, your loan-to-value ratio matters. In addition, the type of loan product you choose and the lender you work with also matter.
Rating of 5/5 based on 4 votes.
Cashback & Bonus Offer
New Offer! Get up to $2,000 cashback + a $50 bonus on signing up. Conditions apply.
Earn 5% Cash Back With Neo
Earn an average 5%¹ cash back at thousands of partners and at least 0.5%² cashback guaranteed.