What Is Loan To Value Ratio

Loan to Value (LTV) Ratio is a commonly used term in the financial world that describes the ratio of a loan amount against the value of an asset being purchased. Lenders will use this ratio to assess how much risk they’d assume if they approve a loan. 

Understanding how a Loan to Value Ratio works is important if you’re considering taking out a loan or attempting to secure traditional financing for real estate in the near future.

Learn more about what Loan to Value means and why it’s important in the world of lending, as we cover everything from
how to calculate LTV, to how it’s used, to what effects it has on interest rates, and more. 

Loan To Value (LTV) Meaning 

Loan to Value can be defined as the number lenders use to understand how much risk they will assume on a loan. They use this ratio any time they lend a borrower money for a secured loan for real estate. At its core, an LTV calculator just shows a number that’s used to hopefully reassure a lender. If the LTV is too high, the chance of a loan being approved is significantly less. 

Think of it this way: the higher the LTV is, the bigger the risk is to a lender. If an asset is worth $100,000 and a borrower needs a $50,000 loan, the LTV is 50%. As noted, the concept of LTV is most commonly used on mortgage loans (although it really can be applied to any secured loan). 

How to Calculate LTV

Figuring out how to calculate LTV ratio is actually very simple. You just need to divide the amount being borrowed by the asset’s value. You then simply multiply that number by 100 to figure out the percentage. 

(Amount Borrowed / Appraised Asset Value) * 100 = LTV

Example #1: You want to purchase a home that appraised for $400,000 and you need to borrow $360,000 to do it. 

(360,000 / 400,000) * 100 = 90% LTV

Example #2: You want to purchase a home that appraised at $600,000 and you are trying to borrow $525,000. 

(525,000 / 600,000) * 100 = 87.5% LTV

Example #3: You hope to buy a property with an appraised value of $300,000 and you will need a loan for $240,000. 

(240,000 / 300,000) * 100 = 80% LTV

Determining LTV is important for underwriting because any lender will want to do everything they can to assess the risk they take on any money they loan out. 

How LTV is Used

An LTV calculation is used by lenders during the underwriting (approval) process when borrowers are purchasing a home. It’s also a factor when a borrower attempts to refinance their mortgage (often to get a lower interest rate), or when they want to borrow against the equity they’ve earned on their home (if a home’s value has increased). 

The amount of a down payment, the appraised value of a property and the sale price will all have an impact on LTV ratios, which can impact a home buyer in that if the LTV is too high, a loan can easily be denied. 

Does LTV Affect Interest Rates?

Lenders use risk-based pricing as one factor in determining interest rates. While a higher LTV doesn’t necessarily rule out a loan, a higher interest rate may result in order to protect the lender. A borrower with an LTV of 95% may have a loan with a full point higher interest rate than one who has an LTV of 80%. Additionally, borrowers with a higher LTV (typically above 80%) may be required to carry additional insurance on their loan. Private Mortgage Insurance (PMI) can further protect lenders on high-risk loans.  

What is a Good LTV?

There’s really no hard and fast rule on what’s a “good” LTV. That said, 80% tends to be a tipping point for most mortgage lenders. While it ultimately depends on the type of loan, staying under 80% can most often help avoid PMI (which can add tens of thousands of dollars to the total loan repayment amount). 

FHA - Federal Housing Administration (FHA) loans typically need less of a down payment and will accept less than stellar credit scores while still approving loans. Because they are designed for low- to moderate-income borrowers, loan approvals can have less stringent requirements.

FHA loans will most often be approved with LTV ratios of up to 96.5% (with a Mortgage Insurance Premium, or MIP)

VA - VA loans are designed for former or current military service members. While LTV Ratios can be higher with this type of loan, there are additional fees to be aware of.

LTV ratios on VA mortgage loans can be as high as 100%, even without PMI. 

How to Lower LTV

It is possible to lower the LTV of a loan to increase the chance for approval and secure a lower interest rate. Options for doing so can include:

  • Making a larger down payment - the bigger the down payment you can make, the lower your LTV will be.
  • Look at properties that are priced lower - older or smaller homes that are more affordable can drastically reduce your LTV, increasing your chance of being approved for a loan. 

Limitations of LTV

If you’ve wondered what does LTV mean in terms of getting approval on a mortgage loan, you should keep in mind that on its own, LTV isn’t an exact indicator or solid predictor of loan approval. Other factors, such as a borrower’s credit score, past payment history, total debt to income ratio and more can influence whether or not a loan will be approved. 

How Connect Invest Uses LTV

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