A loan-to-value (LTV) ratio compares the amount of debt required to purchase a home to the value of the house being purchased.
LTV is important because it is used by lenders to assess whether or not to grant a loan and/or what terms to offer a borrower. The larger the LTV, the greater the lender's risk—if the borrower defaults, the lender is less likely to recoup their investment by selling the home.
The loan-to-value ratio is a straightforward computation that compares the amount of money borrowed to buy an object to its value. It also displays how much equity a borrower has in the home used to secure the loan—how much money would be left over if the borrower sold the home and paid off the debt.
The LTV is the reverse of the down payment made by the borrower. For example, a borrower with a 20% down payment has an LTV of 80%.
What constitutes a good LTV varies depending on the type of asset being financed. When purchasing a home, an LTV of 80% or less is generally regarded as good—this is the limit you cannot surpass if you want to avoid paying mortgage insurance. Borrowers must make a down payment of at least 20%, plus closing fees, to obtain an 80% LTV.
While 80% is regarded as appropriate, conservative homeowners may prefer even lower LTVs to minimize monthly payments or qualify for better interest rates.
To calculate your loan-to-value, simply add the total amount borrowed against an asset. The total should then be divided by the appraised value of the property being financed.
It's also crucial to remember that the loan amount may include charges that lenders allow borrowers to finance rather than pay upfront at closing, such as loan document preparation and filing fees. However, because those expenses do not add to the property value, they improve your LTV.
Making a larger down payment when purchasing a home is one method for lowering your LTV. If you borrowed $400,000 with a $10,000 down payment, your LTV would be 97.5%. If the LTV surpasses 97%, a conventional loan cannot be acquired. As a result, you'd need to put down at least $12,000 to increase your LTV to 97%.
Another way to minimize your LTV when buying a property is to choose a less expensive residence. Putting down $10,000 on a $300,000 house instead of a $400,000 house results in an LTV of approximately 97%.
Paying down your loan's principal reduces your LTV. If the value of your home rises, your LTV will decrease.
To get approved for a home loan, it's best to plan on putting down at least 20% of the home's value—this would result in an LTV of 80% or less. If your LTV reaches 80%, your loan may be denied or you may be required to acquire mortgage insurance to be approved.
LTV is also crucial because if you're buying a home and the appraised value is significantly lower than the purchase price, you may need to make a higher down payment so that your LTV doesn't exceed your lender's limitations.
If you currently own a house and are considering a home equity line of credit (HELOC), most lenders will allow you to borrow up to 90% of the value of your home when paired with your existing mortgage. If the value of your home has dropped since you bought it, you may be unable to obtain a home equity loan or HELOC.
Assume you own a $100,000 home that you purchased five years ago. Your current LTV is 65% if you have a mortgage with a balance of $65,000. If your credit is good and you qualify for additional financing, you may be able to borrow up to $25,000 through a HELOC, increasing your total LTV to 90%.
Finally, if you already have a loan and your house value declines to the point where your LTV exceeds your lender's limits, most home loans aren't callable, which means the lender can't demand repayment before the loan term expires. However, some HELOCs are. Alternatively, if the term of your HELOC is about to expire, your lender may opt not to renew it. If you have a balloon mortgage, you may encounter difficulties refinancing your balloon payment at the end of your loan.
While a loan-to-value ratio considers the amount borrowed against a home about its value, combined LTV considers the total amount borrowed against the value of a home across multiple loans.
This is essential because, in contrast to many lenders, combined LTV includes the total amount borrowed in any loan secured by the property, including first and second mortgages, home equity lines of credit, and home equity loans.
Loan-to-Value Requirements for Various Mortgage Types
Every lender and loan type has its own set of constraints and restrictions, including the LTVs of borrowers. Some even have two thresholds—for example, an absolute limit and a minimum required to avoid additional protections like mortgage insurance.
Conventional mortgages follow lending guidelines established by government-sponsored enterprises such as Fannie Mae and Freddie Mac. These loans comprise the great majority of all mortgages issued in the United States. Lenders set a limit LTV of 80% on traditional mortgages for borrowers who want to avoid acquiring private mortgage insurance. Borrowers who are prepared to acquire mortgage insurance may be able to get up to 97% LTV if the lender improves.
Mortgages Guaranteed By The FHA
The Federal Housing Administration makes FHA loans directly to homeowners. These loans are specifically designed to encourage homeownership among borrowers who would be unable to afford a down payment on a regular loan. The maximum loan-to-value ratio for FHA loans is 96.5%.
It's also worth noting that all FHA loans require borrowers to purchase mortgage insurance as part of the loan program, so greater down payments don't save homeowners money.
VA loans are government-backed mortgages intended exclusively for members of the United States military and veterans. Eligible borrowers can finance up to 100% of a home's worth through VA loan programs. Borrowers are often still responsible for paying any fees and other closing costs that, when combined with the purchase price, exceed the home's value.
USDA loans are government-backed loans granted directly by the United States Department of Agriculture. Department of Agriculture and are intended to assist rural residents in affording homeownership. Home purchasers can finance up to 100% of the purchase price of an existing home using the USDA's home loan programs. For existing home loans, the USDA will frequently cover "excess expenses" (those that exceed the home's worth), such as: