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Friday 07/28/2017 Mortgage Rates

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The Loan-To-Value Ratio

Here you will find all you need to know about loan-to-value in terms of how its ratio is derived, how it calculates your home equity and down payment, and how it plays into your refinancing plans and credit score.

Knowing how to use the LTV ratio to your advantage will give you more control over the outcome of your mortgage, refinancing, and home equity building.

The points covered in this article are:

  1. Definition of loan-to-value (LTV).
  2. How the loan-to-value ratio.
  3. What it means for refinancing and home equity.
  4. Alternative solutions to common problems for low LTV (or low-income) homeowners.

Loan-To-Value

The first thing your lender examines when you want to refinance is your home's loan-to-value (LTV) because, with it, they can quantify the risk associated with a mortgagor. They do this by dividing the appraised home value by the size of the loan. In other words, LTV expresses your home's appraised value in terms of a percentage against the size of the loan. 

The higher the LTV, the more expensive the mortgage is going to be because it represents a greater risk to the lender. In such an event, your lender might put forth the condition that you purchase mortgage insurance to protect them if you fail to pay your debt by the end of the loan term.

The LTV Ratio in Action

Suppose your house's appraised value is worth $180,000 and the size of the loan is $130,000. To derive the LTV ratio all you need to do is divide the loan amount by the appraised value of the house. In this case, 130,000 ÷ 180,000 = 0.72. Converted to a percentage, we get a 72% LTV, which is well within the "low-risk" threshold for mortgage eligibility. The remaining 28% is your home equity, which you can choose to roll with your down payment or only 20% of it with 8% left in your pocket.

Your down payment is also your lender's safety net or "haircut" in the case that you fail to pay the loan. Understand that since your LTV is low, you're considered a low-risk mortgagor and that qualifies your mortgage for better interest rates and lower monthly payments for the loan as a result. It's only when your LTV is more than 80% that you will incur heavier interest and larger payments.

LTV Affects Refinancing and Credit

This ties into refinancing because having good home equity makes refinancing smoother and bound by fewer restrictions. Refinancing of any kind will hinge on the level of risk associated with your home, from the lender's perspective. If your LTV ratio is higher than 80%, you will be looking at higher interest rates or private mortgage insurance (PMI). To avoid higher rates and paying for insurance, try lowering your LTV.

Achieving good LTV from the get-go also keeps your credit in good standing, which is essential for more affordable mortgages and more refinancing options.

LTV and Home Equity

The LTV also indicates the size of your home equity. Your home equity depends on the interest rates and the size of the principal. The lower your LTV ratio, the more equity your home is sitting on. For most homeowners, the ideal LTV ratio should be 80% or less, as per Fannie Mae and Freddie Mac's underwriting guidelines. Borrowers with an LTV greater than 80% are "high-risk" for lenders because of the unsubstantial home equity present. 

Home equity is very important to lenders because it is the only backdrop they have should the borrower default or file for foreclosure.Your lender will assume rights to your house if you fail to pay off your mortgage. For this reason, borrowers with a low LTV receive mortgage loans with low-interest rates because they're considered low-risk. 

Options for Low-LTV Homeowners

Homeowners with low income (high-risk mortgagors) - hence, having an LTV ratio approaching 100% - can find alternative mortgage plans provided by the following institutions:

  • The United States Department of Agriculture's "Rural Housing Loans" allow for a 100% LTV ratio mainly for, but not exclusively to, rural homeowners.
  • The VA loans allow our fellow veterans to have a 100% LTV ratio and a chance at scoring a decent mortgage.
  • The Federal Housing Administration's (FHA) mortgages are not exclusive to any location or group of people. They provide mortgages for low-income homeowners with an LTV ratio of 96.5%. Although, you will need to pay a mortgage insurance premium (MIP) to be approved.
  • Fannie Mae or Freddie Mac's Conventional Loans only require a 3% down payment to be eligible but you do need to provide them with private mortgage insurance (PMI).

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