Mortgage Q&A: “What is the loan-to-value ratio?”
If you’re currently shopping for a home loan, chances are you’ve heard the phrase loan-to-value ratio get thrown around on more than one occasion.
Regardless of what’s going on in the housing market, you should know this important term when applying for a mortgage to ensure you get the best deal as it can greatly affect mortgage rate pricing and loan eligibility.
How to Calculate the Loan-to-Value Ratio (LTV)
Put simply, the loan-to-value ratio, or “LTV ratio” as it’s more commonly known in the industry, is the mortgage loan amount (or existing balance for a refinance) divided by the purchase price or current appraised value of the property.
When calculating it, you will wind up with a percentage. That percentage is your LTV.
It’s actually very easy to calculate (no algebra required) and takes just one step.
Let’s calculate a typical LTV ratio:
Property Value: $500,000
Loan Amount: $350,000
Loan-to-value Ratio (LTV): 70%
In the above example, we would divide $350,000 by $500,000 to come up with a loan-to-value ratio of 70%.
Using a basic household calculator, not a so-called “LTV calculator,” simply enter in 350,000, then hit the divide symbol, then enter 500,000. You should see “0.7,” which translates to 70% LTV. That’s it, all done!
This means our hypothetical borrower has a loan for 70 percent of the purchase price or appraised value, with the remaining 30 percent the home equity portion, or actual ownership in the property.
LTV ratios are extremely important when it comes to mortgage rate pricing because they represent how much skin you have in the game, which is a key risk factor.
A Lower LTV Ratio Means More Ownership, Better Rate
- The lower your LTV
- The more home equity or down payment you have
- Which is another way of saying ownership
- A low LTV equates to a lower mortgage rate
Essentially, the lower the loan-to-value ratio, the better, as it means you have more ownership (home equity) in the property. Someone with more ownership is less likely to fall behind on payments or foreclose, seeing that they have a greater equity stake, aka financial interest to keep paying the mortgage each month.
Not only that, but banks and mortgage lenders also set up pricing adjustment tiers based on the LTV ratio. Those with lower LTV ratios will enjoy the lowest interest rates available, while those with high LTVs will be subject to higher closing costs and rates.
For example, if you’re being hit for having a less-than-stellar credit score, that adjustment will grow larger as the loan-to-value ratio increases (higher LTV ratio = greater risk).
So if your mortgage rate is bumped a quarter of a percent higher for a loan-to-value ratio of 80%, that same pricing hit may be increased to a half percentage point if the LTV ratio is 90%.
This can certainly raise your interest rate in a hurry, so you’ll want to look at all possible scenarios with regard to down payment and loan amount to keep your LTV ratio as low as possible.
More importantly, just maintain an excellent credit score and you’ll have plenty of loan options, regardless of down payment or home equity.