When researching the home buying and lending process, odds are you’ve encountered the acronym LTV at some point. But what does LTV mean and why does it matter? Read on to find out!
What is LTV?
LTV stands for loan-to-value ratio. Expressed as a percentage, LTV is the difference between the mortgage amount and the market value of a property. This compares the size of your loan to the value of the home you’re purchasing.
Why is it Important?
A loan-to-value ratio is very important to your lender because it represents how risky your loan is to them. The more money you borrow compared to the value of the home, the riskier the loan is to your lender because they have more money at risk if you were to default on the loan. The lower your loan-to-value, the less risky it is to a lender. Therefore, a lower LTV can improve your chances of getting a lower interest rate; conversely, a higher LTV may result in a higher rate.
How to Calculate It
A loan-to-value ratio is easy to calculate. Simply divide the loan amount by the purchase price or, in the case of refinances, the appraised value. Let’s say you want to buy a home valued at $300,000 and are able to put down 15% which is $45,000. Take $300,000 minus $45,000 to get $255,000 as the loan amount. To calculate LTV, divide $255,000 (loan amount) by $300,000 (home value) to get 0.85. Loan-to-value is always expressed as a percentage, so a result of 0.85 would translate to an LTV of 85%. In general, the higher your down payment, the lower your loan-to-value.
What is a Good LTV?
What is considered a “good” loan-to-value ratio depends on what kind of loan you’re applying for. When it comes to conventional mortgage loans, 80% is generally considered a decent LTV ratio. This makes sense when you consider that many lenders look for buyers to pay at least 20% as a down payment. That said, if your LTV is higher than 80%, it doesn’t necessarily mean you won’t be approved or will be saddled with a higher interest rate. There are also some programs that allow for higher loan-to-value ratios. FHA loans allow down payments as low as 3.5% which means a loan-to-value of 96.5% is acceptable. USDA and VA loans may allow no down payment at all, meaning an LTV of 100% can even be acceptable. In general, you still want to aim for a lower loan-to-value, but having one that’s higher doesn’t have to make or break your ability to get a desirable loan.
Want to know more about calculating your home equity? Read more here.
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