Apr 09 2021by John Matheson

What Is A Good Loan To Value Ratio?

You've read a million times that you want to have a good loan to value ratio, but that raises one big question: just what is a good loan to value ratio? And why does it matter so much? We will teach you what this term means, why it is important, how to calculate a loan-to-value ratio, and much more.

Understanding Loan to Value

Often referred to as LTV, the loan to value ratio is a term lenders use to describe the ratio of a loan to the property's value. The LTV looks only at the ratio of the first mortgage as a percentage of the property's appraised value. Put simply: the loan to value ratio refers to how much you are borrowing to buy a property versus how much it is worth.

The Importance of LTV

Financial institutions and lenders will consider the loan to value ratio before approving a mortgage. The higher the LTV is, the higher the risk is considered to be. You can still get approved with a high loan-to-value ratio, but you should expect to see much higher interest rates and will likely be required to purchase mortgage insurance.

If you are trying to get approved for a $200,000 mortgage on a property that is worth $210,000, the bank has a higher risk than if you only wanted a $100,000 loan. Why? Because if you defaulted on the loan, their only recourse is foreclosure. If the property is worth $210,000 and you owe $200,000, the bank will not be able to recoup their costs during a foreclosure.

On the other hand, if you only owe $100,000 on a $200,000 property, they can sell the home in foreclosure for less than it is worth and still recoup their losses.

Loan to Value Ratios Lenders Want To See

Not all lenders have the same expectations for qualifying a loan to value ratio as good or bad. However, most lenders offer the lowest interest rates for loan-to-value ratios at or below 80%. Note that just because a borrower does not meet this 80% threshold does not mean that they will be ineligible for a loan, but it does generally mean that they will pay more in interest.

For example, a borrower with a loan to value ratio of 95% might be approved but should expect to be offered a full percentage point higher for their interest rate than what would be offered to a borrower with a 75% LTV.

If the LTV is higher than 80%, lenders often require that the borrower purchase private mortgage insurance (PMI), which can add as much as 1% to the loan's cost every year. If the loan were $1,000,000, then a PMI with a 1% rate would add another $10,000 to the loan's cost every year. Once the LTV on the loan is at or less than 80%, PMI is no longer required.

The industry standard is that a loan with less than 80% loan to value will require PMI, but there are exceptions. Borrowers with high incomes, large investment portfolios, or little to no debt might not be required to purchase PMI.

Typical Loans With LTV Rules

Some of the most common loans have specific rules regarding loan-to-value ratios.

• FHA Loans. Designed for low- to moderate-income borrowers, FHA-approved lenders fund these loans, and the FHA then insures the loans. These loans require lower down payments and credit scores than do most other conventional loans. A person can get approved for an FHA loan with an initial loan to value ratio of as high as 96.5% but will be required to purchase mortgage insurance premium, which is required for the length of the loan regardless of how low the LTV gets. However, the homeowners can refinance to a different loan that does not have that requirement when they reach 80% LTV.
• VA and USDA loans. Current and former military members, or people who live in rural areas, might qualify for these loans, which can be as high as a 100% loan to value ratio. They also do not require private mortgage insurance regardless of the LTV. That said, they both do have additional fees.
• Fannie Mae and Freddie Mac. HomeReady loans from Fannie Mae and Home Possible mortgages from Freddie Mack are designed for low-income borrowers and can provide loans for LTV ratios of up to 97%. They do require mortgage insurance, but only until the LTV falls to 80% or less.

FHA, VA, and USDA loans all offer streamlined refinancing options that waive appraisal requirements, which means that the LTV does not affect the loan terms. There are also options for borrowers who are "underwater" – meaning they owe more than 100% of their home's value – through Fannie Mae and Freddie Mac refinance options.

How To Calculate Loan-To-Value Ratio

To determine the loan-to-value ratio of a property you are considering, you will divide the amount of the mortgage by the property's appraised property value. For example, if the property is worth $100,000 and you are taking out a $90,000 loan, you would divide $90,000 by $100,000 to 0.9. You then express that number as a percentage: 90%.

Another more complex example is a home worth $459,999, and the loan will be for $385,000. Once again, we divide the loan amount ($385,000) by the value of the home ($459,999) and get 0.836. You would round up to 0.84 and then express it as a percentage: 84%. Many online calculators can do the math for you.

Frequently Asked Questions about Loan To Value Ratio

After reading the basics of LTV, you might still have questions. Following, you will find answers to some of the most common questions about loan-to-value ratios.

What is a CLTV?

The loan to value ratio (LTV) refers to the impact that a single loan would make when buying a property. The CLTV is the combined loan-to-value ratio that takes into consideration all the secured loans on the property. This could include second mortgages, home equity lines of credit, and other liens. If a buyer has a high credit rating, they might approve a lender with a CLTV of 80% or higher but will not generally approve them with lower CLTV or for buyers with bad credit.

Why is the Loan to Value Ratio So Important to Lenders?

LTV ratio is one of the best ways for a lender to determine how much risk they are taking on when they offer a loan. Statistics are clear that a borrower with a lower LTV is less likely to default on their loan. Likewise, if they have a lower LTV, then the lender will lose less money if they are required to foreclose on the property.

How do I lower a Property's LTV?

The main elements that make up the loan to value ratio are the amount of money you have for a down payment, the property's sales price , and the appraised value. You cannot change the appraised value, but you could potentially put down a larger down payment or convince the seller to lower the sales price. Those are the two methods that can potentially lower the loan-to-value ratio.

What Types of Loans Are Allowed with the Highest LTV?

A person with a VA loan is not required to put a down payment down at all, thus the LTV can be as high as 100%. Even with other programs that allow for a very high LTV, there is usually some down payment required, even if it is small.

Can I Get Financing with a High LTV?

You might be able to, but it will depend on many factors. Above, you will see several types of loans listed, some of which require as little as 3% down, translating to a 97% LTV. Remember that if you are approved at a higher LTV, you will likely have to pay additional costs (usually in the form of mortgage insurance) and that you will have a higher interest rate.

When Can I Stop Paying Mortgage Insurance?

If you borrow more than 80% of the value of a home, you might be required to purchase mortgage insurance. It generally will cost you between 0.5% and 1% of your loan each year. Once you have your LTV down to the acceptable rate (usually 80%), then you will be able to stop paying mortgage insurance.

Ready to find out your LTV?

It's important to keep in mind that, although financing can be stressful, as long as you have your ducks in a row, things can be as smooth as molasses. Leverage is a tool that automatically calculates your LTV so that you don't have to. It's one less worry and more time than you can spend banking your next investment.