A loan-to-value ratio determines how much of a property you actually own vs how much you owe on the loan you used to buy it. LTVs are used by lenders to judge how hazardous a loan is and whether or not to approve it. It can also help you figure out if you’ll need mortgage insurance.
LTV ratio is an acronym for long-term value ratio.
For example, if you buy a $200,000 home with a $20,000 down payment, you are borrowing $180,000 from the bank. Your mortgage’s loan-to-value ratio would then be 90 percent.
LTVs are part of a larger picture that includes the following elements:
Your credit rating
The amount of money you have available to make monthly payments
The asset’s condition and quality when you’re buying it
With good credit, getting a installment loan with a higher LTV is easy. Your debt-to-income ratio, or your debt payments divided by your income, is one of the most essential factors lenders consider in addition to your credit score. 2 This is a quick way for them to determine how much of a new loan you can afford. Are you able to afford the additional monthly payments, or are you in over your head?
The higher your LTV ratio and the more risk a lender takes, the more money they provide you. If a lender considers you to be a higher risk, it usually means:
Loan approval is becoming more difficult.
It’s possible that you’ll have to pay a higher interest rate.
Additional fees, such as mortgage insurance, may be required.
If you’re calculating LTV, you’re probably dealing with a loan that’s secured by some sort of collateral. When you borrow money to buy a house, for example, the loan is secured by a lien on the property. If you don’t make payments, the lender might take possession of your home and sell it through foreclosure. The same is true with auto loans: if you default on your payments, your vehicle may be repossessed. 3
Lenders aren’t interested in taking your home. They only want assurance that if you default, they’ll receive their money back in some way. If they only lend up to 80% of the property’s worth, they can sell it for less than top dollar to recoup their money.
When you put more of your own money into a purchase, you’re also more inclined to value it and maintain making payments.
When the LTV ratio is greater than 100%, the loan is larger than the value of the asset backing the loan. In that instance, you have negative equity. You’d have to pay anything to sell the asset, and you wouldn’t get anything in return. These loans are commonly referred to as “underwater” loans.