What is loan-to-value ratio?

Getting approved for a mortgage requires more than just telling the lender how much you want to borrow and submitting documents. A lender wants to know it can recoup its money if you fail to repay. Lenders assess this risk by calculating the loan-to-value ratio.

Loan-to-value ratio measures the amount of money borrowed against the value of the home. Generally, the lower the loan-to-value ratio, the lower the risk for a lender — and the more favorable the loan terms.

Key insights

• The higher your LTV ratio, the riskier it is for a lender to approve your mortgage.
• 80% or lower is a good LTV for a conventional mortgage or refinance.
• You may have to pay for private mortgage insurance if your LTV ratio is above 80%.
• Government programs (like USDA and VA loans) allow LTVs as high as 100%.

How do lenders calculate loan-to-value ratio?

Calculating LTV ratio is pretty straightforward. Lenders use this formula: LTV ratio = (mortgage amount/property value) x 100.

To calculate your loan to value ratio, use this formula: LTV ratio = (loan amount/asset value) x 100

To calculate the LTV ratio, divide the amount you’re borrowing (your mortgage amount) by the value of the property. According to Jill Underwood, senior loan officer at the lender Movement Mortgage, “The value is based on the appraised value or purchase price — whichever is less.” (For refinanced loans, lenders use the appraisal value.)

Then multiply the result by 100 to get it as a percentage.

As an example, let's say you purchase a home for $150,000 with an appraised value of $145,000. You make a down payment of $30,000, meaning you borrow $120,000 total. To calculate your LTV ratio, divide $120,000 by $145,000, then multiply by 100. This results in an LTV ratio of 82.76%.

What is a good loan-to-value ratio?

A good loan-to-value ratio increases your likelihood of being approved for a home loan. A lower LTV ratio can also mean getting a lower interest rate and avoiding private mortgage insurance (PMI). There are different LTV requirements by mortgage type:

• Conventional mortgage: The LTV ratio on a conventional loan can be as high as 97%, but if it’s above 80%, the lender usually requires PMI.
• FHA loan: If you’re trying to qualify for a mortgage backed by the Federal Housing Administration (FHA), the LTV requirement will be based on your credit score. For those with credit scores of 580 or higher, the maximum LTV ratio is 96.5%. For those with credit scores between 500 and 579, the maximum LTV ratio is 90%.
• USDA and VA loans: Because you can get both these types of loans with zero down payment, LTV ratios of up to 100% are acceptable for applicants who meet certain requirements.
• Conventional refinancing: Refinance lenders typically require an LTV ratio of 97% or lower.
• FHA streamline refinance: This refinance program has no LTV limits.

Why does LTV matter?

Lenders use LTV ratio to assess the risk they assume by lending you money. Lenders believe that homebuyers with lower LTV ratios are more likely to be able to pay off their mortgage, said Brian Koss, executive vice president of Mortgage Network, an East Coast mortgage company that lends in 26 states.

“When you have sunk more money into the property by making a large down payment, you’re probably not going to walk away from your mortgage,” he added.

That’s why conventional mortgage lenders are more likely to approve and offer lower interest rates to borrowers with lower LTV ratios (generally under 80%).

On the flip side, the higher your LTV ratio, the riskier the loan is for the lender.

To help offset some of that risk, conventional lenders often require private mortgage insurance if your LTV ratio is higher than 80%. PMI for a conventional mortgage typically costs around 0.5% to 2% of the loan amount per year.

A lower LTV ratio can eliminate the PMI requirement altogether, though. You can also request that PMI end when the LTV ratio reaches 80%, and the loan servicer must automatically terminate PMI once the LTV ratio reaches 78%.

You may also be able to eliminate PMI when refinancing, as was the case with a reviewer from Florida. To deal with an increase in homeowners insurance costs, they turned to refinancing: “I thought ‘All right. Let's get rid of the PMI and that will soften the blow of the insurance,’” they told ConsumerAffairs. “And that's exactly what happened. The appraisal was just fantastic, and enabled us to get rid of PMI and do everything we wanted to do.”

How can you lower LTV?

A lower LTV ratio benefits both you and your lender. It makes the loan less risky for the lender, so they’re more likely to offer you a lower interest rate. The following can help you lower your LTV:

• Increase your down payment: The more money you’re able to put down on your home upfront, the less money you need to borrow as principal.
• Lower your purchase price: If you keep your down payment the same but buy the home for a lower price — or buy a more affordable home — you won’t need to borrow as much money.
• Get a new home appraisal: Appraisal value has the biggest effect on your LTV when you’re refinancing. If the new home appraisal increases your home’s value, your LTV will decrease.

Bottom line

Loan-to-value ratio is one factor mortgage lenders use when evaluating a home loan application; basically, it helps assess how risky it is to lend a borrower money.

The lower your LTV ratio, the better your chances of avoiding PMI on a conventional loan and securing a lower rate. You can always lower your LTV ratio by making a larger down payment or negotiating a lower purchase price.