The loan to value (loan-to-value/LTV) is one of the factors evaluated by the lenders in determining a borrower’s eligibility for a loan and the loan’s soundness too. This is a ratio of the loan amount to the value of the asset being purchased, expressed in a percentage. The LTV ratio is more commonly used in home loans and auto loans, as well as boat loans, RV loans, and other financing products that require an asset as collateral.
For the lender, the LTV is a yardstick that measures the “risk” of a borrower and his/her loan.
Loan to Value Ratio in Mortgages
To obtain the value of the property in calculating the LTV, the property is subject to an appraisal. This will determine if the home is priced right on the market or not. In case the seller sells the home for less than its market value, the lender will choose the lesser of the appraised value and the purchase price.
Supposing you take out a loan of $120,000 to buy a home with a market value of $150,000. Your LTV, which is loan amount/value of collateral or $120,000/$150,000 x 100%, is 80%. The remaining 20% will be covered by your equity or downpayment.
By conforming loan standards, an 80% LTV is considered low and would mean to the lender that you are a low-risk borrower, that you are less likely to default on on your mortgage. This low LTV ratio may be used to compensate a low credit score, a high debt-to-income ratio, a low income, and other qualities that make a borrower “high-risk”.
There are instances when a lender allows for a high LTV when the borrower is most creditworthy, approving a 100% financing.
Higher LTV Loans
The greatest benefit of a low LTV (80% or less) is not paying any private mortgage insurance that the lender will ask of those with higher LTVs.
The lender may also ask the borrower with a high LTV to put down a higher downpayment.
But not all homebuyers, first-time homebuyers included, can afford to put down 20% or even 10% of the home’s purchase price. Against this backdrop, these programs allow for a higher LTV limit and low downpayments:
- FHA loans – downpayments can be as low as 3.5% and can finance up to 96.5%.
- VA loans – downpayments can be 0% and can finance up to 100%.
- USDA loans – downpayments can be 0% and can finance up to 100%.
- Fannie Mae’s HomeReady™ – downpayments can be as low as 3% and can finance up to 97%.
- Freddie Mac’s Home Possible™ – downpayments are between 3% and 5% and can finance up to 97%.
It’s not just in buying a home that an LTV is useful. When you refinance your existing mortgage, the lender will order another appraisal to reflect the new value of your home (as price goes up or down) relative to your outstanding mortgage balance. If you owed more than your home’s valued, you have negative equity.
Loan to Value Ratio in Auto Loans
Cars are valued differently from homes. Their book value is based on Kelley Blue Book and NADA for new and used cars or manufacturer’s suggested retail price (MSRP) for new vehicles.
The formula to calculate the car loan’s LTV is the same with mortgages. And the implications of having a high or low LTV in a car loan are similar to home loans in that the lender could require a larger downpayment if your LTV proved to be high.