Loan-to-Value Ratio Explained


If you’re looking at getting a mortgage, then you have heard the term loan-to-value ratio, also called the LTV ratio.

This article discusses the loan-to-value ratio, what it is, why it’s important, and how to calculate it.

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What is a Loan-To-Value Ratio?

The loan-to-value ratio is the loan amount compared to the appraised market value of a property. Lenders use the LTV ratio to determine the amount of equity a borrower has and to assess risk.

If you are using a 5% down payment and financing the rest of the purchase, your loan-to-value ratio will be 95%.

The lower the LTV ratio is on a mortgage, the less risky it is, leading to better loan terms and a lower rate.

How to Calculate the Loan-to-Value Ratio

To calculate the LTV ratio, divide the loan amount or loan balance by the property’s appraised value.

New Home Purchase

When purchasing a home, calculating your DTI ratio is easy. If you are putting 5% down, your DTI ratio is 95%, 10% down = 90% DTI, and so on.

For a $200,000 home with a loan amount of $180,000, take 180,000 and divide by 200,000 it equals 0.9. Move the decimal over to get 90%.

  • Enter 180,000 on your calculator or phone.
  • Divide it by 200,000
  • You’ll get 0.9, or 90%; this is your LTV ratio.

 

Existing Homeowners

If you want a home equity loan or cash-out refinance, you will be able to convert up to 80% of your home’s equity.

For example, if you have a home with a market value of $200,000 and a loan balance of $100,000, your current loan-to-value ratio is 50%. You will be able to get a loan up to 80% of the LTV ratio, or $60,000 minus closing costs.

Current Home Value

$200,000

Current Loan Principle Balance

$100,000

New Loan (max 80% market value)

$160,000

Payoff Current Loan

-$100,000

Subtract Closing Costs

-$4,500

Max Cash-Out Amount

$55,500

The Maximum Loan-to-Value Ratio for a Mortgage

Mortgage loans have a maximum LTV ratio. There are only two types of mortgages that offer 100% financing. VA and USDA. Every other mortgage program available requires a lower DTI ratio. Here are the max LTV ratios for each type of mortgage.

FHA and 203k Loans

FHA loans and FHA 203k loans are a government home loan that offers a low 3.5% down payment to borrowers with a 580 credit score or higher. Mortgage insurance premiums (MIP) are required regardless of the LTV ratio. FHA Requirements state that borrowers with 10% down (LTV ratio below 90%) will only have to carry MIP for 11 years. Borrowers with an LTV ratio above 90% will have MIP for the life of the loan.

VA and USDA Loans

USDA and VA Loans are the two types of home loans with a maximum LTV ratio of 100%. VA loans do not require a down payment, and borrowers are not required to carry mortgage insurance. USDA loans offer 100% financing as well.

Conventional Loans

Fannie Mae and Freddie Mac are government-sponsored entities that are the largest two buyers of mortgages on the secondary market. The maximum LTV ratio will depend on the type of conventional loan you get.

A conventional 97 loan is a conventional mortgage that will finance 97% of a property; borrowers will only need 3% down. Mortgage insurance is required on conventional loans with an LTV ratio above 80%. The PMI will be dropped once the LTV ratio reaches 78%.

Maximum LTV Ratio by Loan Type

  • FHA Loans – 96.5% LTV
  • VA Loans – 100% LTV
  • 203k Loans – 96.5% LTV
  • USDA Loans – 100% LTV
  • Conventional Loans – Up to 97% LTV
  • Jumbo Loans – 85% LTV

 

The Loan-to-Value Ratio Affects FHA Mortgage Insurance Rates

Mortgage insurance (PMI or MIP) is insurance on the loan if the borrower defaults on the loan. For most mortgages, PMI is required for mortgages with an LTV ratio above 80%. This equals big savings for homebuyers because of mortgage insurance costs between 0.51% – 0.85% of the loan amount annually. By putting at least 20% down, you will save thousands of dollars each year.

$625,500 Loan Amount and Lower

Down payment

MIP rate

MIP duration

30-year loan

<10%

>10%

0.85%

0.80%

Life of the loan

11 years

15-year loan

>10%

0.45%

0.70%

Life of the loan

11 years

Mortgage Insurance Required for Loan-To-Value Ratio Over 80%

If you get a mortgage and have an LTV ratio above 80%, you’ll be required to pay mortgage insurance unless you have a VA loan, which doesn’t require mortgage insurance.

Mortgage insurance premiums are around 0.50% – 0.85% of the loan amount and it’s included in your monthly payment.

When Your LTV Ratio is Over 100%

When the housing market is down, home prices will begin to fall. If your home is worth less than the principal balance on your mortgage loan, you’re considered underwater. Being underwater on your mortgage means you owe more than it’s worth.

Fortunately, government programs can help borrowers who are underwater to refinance their mortgage and get a lower monthly payment and rate.

Home Affordable Refinance Program

Borrowers unable to refinance their loan because the value of their home has declined may be eligible through HARP to lower their monthly payments.

Principal Reduction Alternative

PRA was designed to help homeowners whose homes are worth significantly less than they owe by encouraging servicers and investors to reduce the amount you owe on your home.

Treasury/FHA Second Lien Program (FHA2LP)

Your second mortgage on the home may be reduced or eliminated through FHA2LP. If your second mortgage servicer agrees, the total amount of your mortgage debt after refinancing cannot exceed 115% of the market value of your home.

What is a Good Loan to Value Ratio?

If you have an LTV ratio of 80% or lower, it’s considered good, presenting less risk to the lender. Not only is having an LTV ratio of 80% good, but you will also avoid having to pay mortgage insurance. A high LTV ratio is anything above 80%, so mortgage insurance is required for loans with an LTV ratio above 80%.

Home Equity Loans and Cash-Out Refinance LTV Ratios

If you’re looking to get a home equity loan, HELOC or cash-out refinance, the loan-to-value ratio is even more important. These loans allow you to access the equity in your home and use it as collateral for a loan. These loans usually max out at 80% loan to value.

For example, if you have a home worth $100,000 and the loan balance is $50,000, you can get a home equity loan for up to $30,000.

Home Appraisals

The home appraisal is critical when figuring your loan-to-value ratio. Property values are constantly in flux; many times, home values increase over time. The purchase price is used for the loan-to-value ratio initially when you get a mortgage. When you go to refinance, the home’s value will be reassessed.

If your home’s value has increased because of inflation or because you made renovations that increased the value, you can get a new home appraisal. Most lenders will have an appraisal done before giving a loan. They want to ensure they are not lending more money than the property is worth.

If you get a low home appraisal, it can really raise your LTV ratio. Before an appraiser comes to evaluate your home’s value, you should take steps to ensure you receive a good appraisal.

Credit Scores

Your credit score is one of the most influential factors that determine borrowers’ risk. The lower the score, the higher the risk. Your FICO score can even affect the loan to value ratio the lender will accept.

FHA loans are available with just a 3.5% down payment to borrowers with at least a 580 credit score. Borrowers with a score below 580 will have to put 10% down because the FHA has a maximum LTV ratio of 90% for borrowers with a FICO score under 580.

If you have poor credit, you will want to have a lower LTV ratio to compensate for your bad credit or high debt-to-income ratios. Having a low LTV ratio is a compensating factor that can help reduce risk and increase your chances of getting approved.

The Bottom Line

The loan-to-value ratio is an important metric used by mortgage lenders to determine risk. Having a low LTV ratio reduces the risk and allows the home buyer to get a mortgage while avoiding mortgage insurance (MIP).

Do you know your loan to value ratio?

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