When it comes time to begin a large home renovation project or even buy a new home, suddenly a lot of new terms come into play. From LTV to DTI to APR, learning all of these abbreviations at once can get confusing. But when you break them down, they’re not that complicated.
Your loan-to-value (LTV) ratio is really a comparison of your loan and your home, but it’s also one of the main factors your lender will consider when deciding whether or not to approve your loan application.
What is an LTV ratio, how do you calculate it, and how do you use it?
We’ll examine the answers to all of these questions and more right here, so let’s get started.
What is LTV?
The LTV ratio compares your outstanding mortgage balance with the appraised value of the property. In terms of home ownership, it measures what you own vs. what is being borrowed.
The more money you’ve paid off, the lower your LTV will be. For example, if your home is worth $500,000 and you still owe $350,000 on your mortgage, your LTV would be $350,000/$500,000 - 70%.
When it comes to applying for a mortgage, the higher your down payment, the lower your original LTV ratio. The lower your down payment, the higher your LTV ratio will be.
Mortgage lenders use LTV when deciding whether to lend to you. The lower the LTV, the lower the risk to the bank. The higher the LTV, the higher the risk to the bank. This is because the potential loss the lender will face if the borrower fails to repay the loan rises, creating more risk.
If you are considered a “high risk” for the lender, you may:
- Have a harder time getting approved for loans.
- Pay a higher interest rate.
- Pay additional monthly costs, such as private mortgage insurance (PMI).
How do you calculate loan-to–value ratio?
To determine your LTV ratio, divide the loan amount by the property value (or purchase price), and then multiply by 100 to get a percentage
LTV = (Loan amount ÷ Appraised value of asset) × 100.
Here’s an example:
Home value: $600,000 | Down payment: 10%
If your down payment is 10% of $600,000, that means it will be $60,000, and you’ll need a mortgage loan for $540,000 to cover the full cost of the home. $540,000/$600,000 = .9 x 100 = 90%.
The sales price may also factor in. For example, if you buy a home that appraises for $100,000, but the owner is willing to sell it for $90,000.
If you make a $10,000 down payment, your loan is for $80,000, which results in an LTV ratio of 80% (80,000 divided by 100,000).
What is a good loan-to-value ratio?
There is no such thing as a “good” LTV, however most lenders have limits for the maximum LTV they will allow. In many cases, an LTV ratio of 80% or less is ideal.
Conventional mortgages with LTV ratios greater than 80% typically require the borrower to pay private mortgage insurance, also known as PMI. This additional expense can add tens of thousands of dollars to your payments over the life of your loan. We’ll cover this in more detail later.
The highest acceptable LTV ratio for a conventional mortgage is 97%, and for FHA loans it’s 96.5%, but the VA and USDA loan programs let you buy a house with nothing down.
This is why we say there is no “good” LTV, it just depends on your financial situation and the type of loan you’re looking for.
LTV requirement for RenoFi Loans
RenoFi Loans have different requirements for the highest acceptable LTV ratio because they’re based on your home’s future value, so you can generally borrow a lot more than you’d otherwise be able to with a traditional mortgage or home equity loan.
In terms of your home’s current value, lenders will not approve a loan amount that puts your LTV above 125%.
If you’re calculating your home’s LTV using your home’s future value (we would call this the ARV LTV), lenders will not approve a loan amount that puts your ARV LTV above 90%.
So for example, say your home’s current value is $400,000, and you have an outstanding mortgage balance of $300,000, and you’d like to take out another loan for $100,000 to increase your home’s future value to $470,000.
If we’re just thinking about your home’s current value, we’d divide $400,000 ($300,000 + $100,000) by $400,000, which puts your LTV at 100%. For traditional loan options, this would be too high, but for RenoFi Loans, this is well under the maximum of 125%.
If we’re factoring in your home’s future value, we’d divide $400,000 ($300,000 + $100,000) by $470,000, which puts your ARV LTV at 85%, under the maximum ARV LTV of 90%.
How to lower your LTV ratio
Need to lower your current LTV ratio? Here are several actions you can take:
- Save up money for a larger down payment.
- Set your sights on a more affordable house.
- Consider an alternative loan option, like a RenoFi Loan, that allows higher LTV ratios.
The lowest LTV ratio is achieved with a higher down payment and a lower sales price. Even though it’s certainly not an easy thing for everyone to do, making a bigger down payment does usually translate to a lower mortgage rate.
If you’re purchasing a home, the important thing is to try and clear the 80% mark, so that you don’t need to pay PMI. PMI is another fun acronym that stands for private mortgage insurance.
The average PMI ranges from .5-1.5% of the total annual loan amount. While this seems small, if your mortgage is $400,000, this is another $4,000 you could be saving for something else.
Your LTV ratio can and will change once you start to repay the loan, but these pesky PMI payments are required until the LTV ratio is 80% or lower.
How does LTV affect interest rates?
A borrower’s LTV ratio can also play a big role in securing an interest rate during the lender’s loan assessment.
Lenders typically follow a practice known as “risk-based pricing,” which involves setting higher interest rates on loans determined to be risky.
For example, borrowers with subpar credit being charged more than those with excellent credit.
The same thinking applies to LTV: Since a high LTV ratio means more risk to the lender, if the mortgage is approved, the higher risk loan typically comes with higher interest rates.
Most lenders offer applicants the lowest possible interest rate when their LTV ratio is at or below 80%.
Example - a borrower with an LTV ratio of 90% may be approved for a mortgage, but their interest rate may be a full percentage point higher than the interest rate given to someone with an LTV ratio of 70%.
The interest on the loan may also rise if the LTV ratio increases, due to something like a smaller down payment.
As stated, to lower your LTV ratio, we recommend making a larger down payment or borrowing less, if that is something you are able to do.
How lenders use your LTV ratio
One of the first things lenders look at is the loan amount you’re requesting compared to the property’s market value.
Other factors lenders look at to determine your ability to repay the loan include your credit score, down payment, and cash flow.
One limitation of an LTV ratio is that it only includes the primary mortgage that a homeowner owes, and does not include other obligations, such as a second mortgage or home equity loan.
For this reason, the CLTV is a more inclusive measure of a borrower’s ability to repay a home loan. It takes into account additional mortgages or loans on a property, like home equity loans and HELOCs.
In terms of a conventional mortgage loan, CLTV is calculated by taking the amount of the combined loans and dividing by the property value.
The traditional LTV calculation also does not take into account alternative loan options based on your home’s future value, like RenoFi Loans, which is why we’ve created the ARV LTV metric:
(outstanding mortgage balance + requested loan amount)/(home’s future value after the renovation) x 100.
LTV vs. CLTV
LTV stands for loan-to-value ratio, while CLTV stands for combined-loan-to-value ratio. In general, LTV only considers the primary mortgage balance on the home.
If you’re applying for a second mortgage or home equity loan, your lender will instead look at your CLTV, or your combined-loan-to-value ratio, which is a metric that includes all home loans.
In general, lenders tend to be more generous with CLTV requirements since it is a more thorough measure.
Lenders are often willing to lend at CLTV ratios of 80% and above and to borrowers with high credit ratings.
If you’re applying for a RenoFi Loan, your lender will look at your CLTV, LTV and ARV LTV.
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