What Is Loan-To-Value Ratio?

What is LTV and why is it important?

A loan-to-value ratio measures the amount of money borrowed against the value of a home.

“The [property] value is based on the appraised value or purchase price — whichever is less,” said Jill Underwood, founder and chief loan officer at Your Mortgage Queen.

Lenders use LTV ratios to assess the risk they assume by lending you money. Generally, the lower the LTV ratio, the lower the risk for a lender, and the more favorable the loan terms. The higher the LTV ratio, the riskier the loan is for the lender.

This is because lenders believe that homebuyers with lower LTV ratios are more likely to be able to pay off their mortgage, said Brian Koss, regional director of Movement Mortgage.

“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,” Koss said.

Lenders use LTV ratios to assess the risk they assume by lending you money.

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%). Conventional lenders often require private mortgage insurance (PMI) if your LTV ratio is higher than 80%. PMI typically costs around 0.5% to 2% of the loan amount per year for a conventional mortgage.

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

How loan-to-value ratios are calculated

Calculating an LTV ratio is pretty straightforward. Lenders use the following formula:

To calculate the LTV ratio, divide the amount you’re borrowing (your mortgage amount) by the value of the property. Note that for refinanced loans, lenders use the appraisal value. Then, multiply the result by 100 to get it as a percentage.

For example, say you purchase a home for $300,000 with an appraised value of $290,000. You make a down payment of $60,000, meaning you borrow $240,000. To calculate your LTV ratio, divide $240,000 by $290,000, then multiply by 100. This results in an LTV ratio of 82.75%.

» MORE: What is a home appraisal and how do they work?

Loan-to-value requirements by loan type

Loan-to-value ratios can vary by loan type, as different loans have different LTV requirements. A lower LTV increases your likelihood of being approved for a home loan and can also mean getting a lower interest rate and avoiding private mortgage insurance.

Here are some of the LTV requirements for different types of mortgages:

Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) and they guarantee many loans in the U.S. Fannie Mae and Freddie Mac loans are generally conventional loans. 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 loans

With Federal Housing Administration (FHA) loans, the LTV requirement varies depending on your credit score. For people with credit scores of 580 or higher, the maximum LTV ratio is 96.5%. For people with credit scores between 500 and 579, the maximum LTV ratio is 90%.

USDA loans

U.S. Department of Agriculture (USDA) loans don’t require a down payment, meaning LTV ratios of up to 100% are acceptable for applicants who meet certain requirements.

VA loans

Like USDA loans, U.S. Department of Veterans Affairs (VA) loans don’t require a down payment, which means you can get an LTV ratio of up to 100%.

How can you reduce your 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.

Consider the following to reduce 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 you’re able to 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 a new home appraisal increases your home’s value, your LTV will decrease.

» MORE: What is the average down payment on a house?

FAQ

Bottom line

A loan-to-value ratio is one factor mortgage lenders use when evaluating a home loan application since it helps lenders to assess how risky it is to lend a borrower money. Generally, the lower your LTV ratio, the better your chances of securing a lower rate and avoiding PMI. To reduce your LTV ratio, consider making a larger down payment or negotiating a lower purchase price.