What is Loan-to-Value Ratio?
What is Loan-to-Value Ratio?
What is Loan-to-Value Ratio?LTV or Loan-to-Value is the ratio between the total money borrowed on a mortgage loan and the total value of the home. It is an important risk factor lenders evaluate while considering applications for mortgage loans. The loan-to-value is calculated by dividing the purchase price of the house by the total loan amount. For instance, if a borrower is purchasing a house worth $200,000 and puts a down payment of $20,000, the loan-to-value ratio would be 90%
Total Property Value= $200,000
Total Down Payment= $20,000
Total Loan Amount= $(Property Value-Down Payment) = $(200,000-20,000) = $180,000
LTV= (Total Loan Amount/Total Property Value)*100%
= (180,000/200,000)*100% = 90%
The purpose of having a loan-to-value ratio in a mortgage loan is to make sure that lenders do not loan money to borrowers for more than the value of the property. This way lenders can protect themselves from potential risks. Another important factor of LTV is that lower the loan-to-value ratio is the more likely the borrower is going to get a lower interest rate and vice versa. Most lenders require 20 percent down payments for conventional mortgage loans. Loan-to-value ratios of 80 percent and below are considered low LTV and lower risk. Lenders consider borrowers with higher LTVs a higher risk; therefore give them a higher interest rate. Also with high LTV ratios where the down payment is less than 20 percent, lenders require borrowers to pay private mortgage insurance (PMI). PMI protects lenders against loss in case borrowers default on their loans. Loan-to-value plays an important role in both the activities of purchasing as well as refinancing an existing mortgage loan.