When applying for a mortgage or refinancing, you are likely to come across some terms that may sound foreign but weigh heavily on a lender’s credit decision. Among those terms, you are likely to encounter the loan to value (LTV) ratio.
This article will discuss how the loan to value ratio plays into the homebuying process. We will answer questions like, ‘what is a loan to value ratio?’ and ‘how do I calculate loan to value ratio?’ You will come away knowing what a low loan to value ratio indicates and should be able to answer, ‘what is a good loan to value ratio?’ as you embark on your homebuying journey.
What Is a Loan To Value Ratio?
A loan to value ratio is a metric that compares the size of a homebuyer’s mortgage to the value of the property after the appraisal.
The homebuyer’s down payment size and the LTV ratio have an inverse relationship. Therefore, the higher the down payment, the lower the LTV ratio.
How Do I Calculate Loan To Value Ratio?
You may want to calculate the loan to value ratio so that no surprises are waiting for you in the homebuying process. There are various LTV calculators available.
If you want to calculate LTV yourself, divide the size of the loan by the appraised value of the property being mortgaged. The result is your LTV ratio.
How Do Lenders Use LTV Ratio?
You may be asking yourself, ‘how is the loan to value ratio typically used?’ One of the ways lenders use the LTV ratio is to assess the risk of issuing a loan to a prospective borrower. The LTV is used in conjunction with a credit score, income, and other factors.
In addition, the LTV ratio is a critical metric used by lenders to determine whether the homebuyer will need to purchase private mortgage insurance, also known as PMI. If a potential homebuyer’s LTV is above a given threshold, they will need to invest in PMI to offset the risk inherited by the lender. The costs of PMI are then added to the monthly mortgage payments.
The PMI is in place to ensure enough equity in the home for the lender to be protected in the case of a default and foreclosure of the house. In this case, the lender can recoup their costs, including interest payments, taxes, and other insurance, as they begin the process of reselling the property.
What Is Considered a Good Loan To Value Ratio?
Before you begin the mortgage application process, you want to know what is considered a good loan to value ratio. The answer is straightforward: lenders are generally looking for an LTV ratio of 80% or lower, though their maximum LTV standards could vary.
For mortgage loans in which lower down payments of 3-3.5% are allowed, such as an FHA loan, the borrower might be expected to continue to pay the PMI for the life of the mortgage. Otherwise, the PMI could be canceled once the borrower’s equity in the home increases and the LTV falls below 80%.
Previously, homeowners had difficulty canceling their PMI once their LTV fell below the 80% threshold. The Homeowners Protection Act, which became law in 1998 and was amended in 2000, addresses this issue. Now there are procedures in place to cancel the PMI once the qualifying LTV standard is met based on the original appraisal value of the property.
What Does a Low LTV Ratio Indicate?
A low LTV ratio illustrates that the borrower has invested enough equity in the home, waiving the requirement to purchase PMI. It protects the lender in the event of a default and foreclosure. Once the LTV is at or below 78-80%, a homeowner is no longer required to have PMI in place, and the lender can cancel the insurance.
If you are satisfied with your LTV ratio and are ready to begin the mortgage application process, Total Mortgage is standing by to help. Receive a free rate quote by answering a few simple questions and see our current low mortgage rates today.
What Does a High LTV Ratio Indicate?
A high LTV ratio is a sign that the homebuyer is making a low down payment relative to the size of the mortgage. It indicates a bigger mortgage, in which case the borrower’s fees will be higher, and the homebuyer’s income must be sufficient to be approved for the loan. In the case of a high LTV ratio, the lender might also require that the borrower have mortgage reserves, which represent cash on hand to pay the mortgage if income is interrupted.
How to Work Out Your Loan to Value Ratio
The LTV ratio is an important metric that will influence the loan terms associated with your mortgage. It will also affect whether the lender will approve your mortgage application. Acceptable LTV ratios will also vary based on the mortgage program, and lenders usually make their maximum LTV ratio level known for a given mortgage product.
Let’s say you’re looking to purchase a home with an appraised value of $300,000, and the lender’s maximum LTV ratio is 97%. To determine the highest loan amount you could be approved for, multiply the property value by 0.97 for a maximum mortgage amount of $291,000. The LTV ratio could also be applied to learn how much cash a homeowner is eligible to receive in what’s known as a cash-out refinancing program.
Steps to Improve Your LTV Ratio
The more equity you build in your home, the better your LTV ratio will be, leading to more attractive terms on your loan and a greater opportunity for refinancing down the road. If you find that your LTV ratio is higher than you’d like it to be, you can take steps to improve this metric.
For example, you can increase the size of your down payment. If you don’t have the cash on hand to do this, see if family or friends might be willing to gift funds toward purchasing your new home.
Also, considering your LTV falls as you make your mortgage payments, you can increase the size of your principal payment beyond the minimum amount to accelerate the process. A shorter-term loan, such as a 15-year mortgage, will also speed up the process to a lower LTV ratio. Additionally, the lower the value of the property you buy, the higher the chances of attaining a better LTV ratio.
Buying a home does not have to be tricky when you know what to expect. Understanding your LTV ratio is one piece of the puzzle that could get you on your way to homeownership.
At Total Mortgage, we have mortgage experts standing by in offices across the country to help you navigate the homebuying process. Find a Total Mortgage office in your neighborhood today to explore your options and get started on your move.