LTV, or loan-to-value, is a ratio used in real estate mortgage transactions that is representative of the total amount of a mortgage with relation to the assessed value of the property or home being purchased or refinanced. LTV is calculated by dividing the overall amount of the mortgage or loan by the assessed property value or sales price. The lower amount of the two is used for the final determination of the LTV. Depending on the nature of the loan, the fair market value of a home may be used in place of an official appraisal depending on the lending institutions rules, state of residence, and type of mortgage being pursued.
Why Should You Care About LTV?
The loan-to-value (LTV) of a mortgage is one of the significant factors used by lenders in making a decision on whether or not to approve a mortgage application. LTV is almost always used in percentage form. For example, if a consumer is taking out a $500,000 loan on a $1,000,000 home, then the LTV of the property or loan would be 50%. Mortgages are said to have high LTVs when the amount of money being borrowed is extremely high as compared to the amount of equity held in the property or the down payment being placed for the purchase of the home. A good example of this would be when a mortgagor puts 10% down on a new home and finances the remainder of the cost of the home/property. This would result in a 90% LTV which is generally considered high in the home loan industry.
Why is LTV Important?
Mortgage lenders will normally look at loans that carry a high LTV as being inherently more risky to their bottom-line than ones where the borrower places a significant amount of money down on the loan or already has a large amount of equity in the home. In the lender’s favor, a borrower who has significantly more money invested in a home in the form of a down payment, etc. will be at less risk to default than someone who has not placed a large down payment on the property. Many times, private mortgage lenders will require individuals with a high LTV to obtain PMI, or private mortgage insurance, to help guard against a high LTV. This insurance protects the interest of the lender in the event that the borrower defaults on the note. When required to purchase PMI, the overall monthly cost of the mortgage note will be increased on a monthly basis until sufficient equity is built up in the home. In some cases, lending institutions will charge a higher interest rate to consumers who are carrying a high LTV.
The Impact of Appraisals on LTV
In an ever-changing real estate landscape in the United States, appraisals play a significant role in all types of mortgage loans. For a high LTV loan, the appraised value of a home or property is critical since the overall transaction can be placed at risk. For example, if someone was buying a home for $200,000 USD and is able to put 5% down, he or she would need a total loan of $190,000. The lender might then agree to finance 95% of the appraised value of the loan. If the home appraisal then comes in at only $195,000, the lender will only provide a loan for $185,250. That would then leave the lender almost $5,000 short in the total funds required to close on the mortgage.
In the cases where a home or property appraises for less than the total amount of money the borrower requires, the home purchase will likely fail to close unless he or she can gather the funds necessary to close the loan. In some cases, borrowers may be able to shift the mortgage transaction to a more lenient lender, though typically at a higher interest rate. If the consumer is using a mortgage broker, making the shift to a new lender will normally be easier since they have a number of contacts in the mortgage industry and can facilitate establishing relationships with new lenders in a short timeframe.
LTV and Underwriting Guidelines
Loans that meet the underwriting guidelines for Fannie Mae and Freddie Mac in the United States must meet a loan-to-value ratio equal to or less than 80%. Loans that are above this percentage are allowed; however, they have to include PMI (private mortgage insurance). If the property has more than a single lien, which include second mortgages or HELOC (home equity lines of credit), they are then scrutinized against combined loan to value (CLTV) criteria. In this case, the LTV would take into account the additional credit taken out against the property against the most recent appraised value. The total debt is then considered by the mortgage company to determine the overall riskiness of the potential mortgagor or borrower.
For home buyers in Australia, the mortgage industry uses loan to value ratio, or LVR to calculate risk for home loans. In this market, if the LVR is equal to or below 80% the note is considered to be low risk for a standard conforming loan. For a no doc or low doc loan, 60% LVR is used to determine low risk. If the loan is insured in the country, higher than 80% LVRs are permitted.
In the United Kingdom, LTVs as high as 125% were commonly approved prior to the mortgage crash in the late 2000s. In today’s economic environment, most home loans in the UK are at or below 75%; however, loans with LTVs up to 90% are approved for those with excellent credit.
How Do You Calculate Loan-to-Value?
The LTV (loan-to-value) ratio of a home or property is one of the significant factors used on the mortgage process. It will help the bank or lender further assess personal debt levels against the amount of money required for financing the loan and if the prospective mortgagor can afford the loan. LTV will also play a significant impact on how many fees or other charges may be added to the loan process. Finally, the LTV will also determine if PMI (private mortgage insurance) is required for the loan or not.
LTV (loan-to-value) is calculated by dividing the amount of funds being borrowed by the total value of the property being purchased resulting in a simple ration. A simple example would be in the case of buying a home that cost $200,000. If the consumer takes out a $160,000 loan to buy the property and provides $40,000 down on the home, the LTV would be 80 percent. Or rather, the mortgage is for 80 percent of the value of the home.
The total value of the property or home is the officially appraised value of the home or the amount paid for the property (market value) depending on which amount is lowest. When initially applying for a mortgage, the property’s value is looked at as an estimate. Most home loans will require a professional appraisal be made before proceeding to close on the home loan.
Steps to Calculate LTV
Step 1 – Write down the purchase price of the home or property to be used as the value of the home. For this example, $200,000 will be used.
Step 2 – Subtract the amount of the down payment from the loan. We’ll use $40,000 in this example. This will give a total amount of $160,000 left.
Step 3 – Confirm the total loan amount. Note, this should equal the total amount calculated from Step 2.
Step 4 – Divide the total loan amount by the total purchase price (value). In this example, that would $160,000 divided by $200,000. This will equal 0.80, or 80 percent which is the ratio on the property.
Step 5 – Provide this number to your lender when referring to the pending home loan. You will want to state that you desire a home loan that has an 80 percent LTV (loan-to-value).
Steps to Calculate LTV for an Existing Loan
Step 1 – Obtain an appraisal of the property or home. Once you have purchased a home, this is the only approved method to obtain a true assessment of a home’s property. If doing out of curiosity, save the money on an appraisal and do an estimate of the value by locating previously sold properties in your neighborhood similar to your home. For a better estimate, only use properties sold in the past three to six months for the estimate.
Step 2 – Locate the balance owed on the most recent mortgage statement. This value will be the amount to use when calculating LTV on an existing loan.
Step 3 – Divide the total amount owed on the loan by the estimated value of the home. This value will be the LTV ratio for the existing home loan.
LTV and Private Mortgage Insurance
When a consumer obtains a new home loan, publicly backed mortgage companies will commonly require PMI (private mortgage insurance) be paid if the LTV does not meet required thresholds. For home loans, the required LTV is commonly set to 80 percent or lower to not require insurance be paid. PMI is not intended to protect the borrower; however, as it helps protect the lender in the event of the consumer defaulting on the home loan. This comes from the lender normally having to sell a property which has been foreclosed on at a discount to recoup funds. Over the history of the mortgage market, this discount can be as much as 20% of the home’s value. Once the LTV of a property drops to 78% of a home’s value, most mortgage lenders will automatically remove PMI from the mortgagor’s payments.
What is CLTV?
CLTV (Combined Loan to Value) ratio is very similar to LTV. The primary difference is that CLTV sums all mortgages against a property and divides this total by the total value of the property or home or purchase price (depending on what value is less).
Steps to Calculate CLTV
Step 1 – Locate your most recent statements for the primary home loan, second mortgage(s), and home equity loans taken out against the property or home. For this example, assume $100,000 is owed on the primary mortgage, $20,000 is owed on a home equity loan, and $40,000 is owed on a second mortgage.
Step 2 – Add the total amount owed on each loan. This value is the total value owed on the home or property. The total amount owed against the home in this example will be $160,000.
Step 3 – Divide the total amount owed by a recent home appraisal or the fair market value of the home. The fair market value will be equivalent to the average sales price of homes of equivalent size in the local area. For this example assume the fair market value of the home is $200,000.
Step 4 – Take the figure determined by dividing the total amount of money owed against the home by the fair market value and multiply by 100 to get the CLTV ratio. In this example, .80 x 100 gives a CLTV or 80%.
Step 5 –If a home or property has multiple mortgages or home equity loans taken out against it, the lending institution will calculate both the LTV (using the primary mortgage) and CLTV (using all notes taken out against the home) to provide two measures of risk when determining if a potential borrower can qualify for a new home loan.