Loan-To-Value Ratio: What It Is And Why It Matters?
A loan-to-value (LTV) ratio is a metric that measures the amount of debt used to buy a home and compares that amount to the value of the home being purchased. LTV is important because lenders use it when considering whether to approve a loan and/or what terms to offer a borrower. The higher the LTV, the higher the risk for the lender—if the borrower defaults, the lender is less likely to be able to recoup their money by selling the house.
What Is Loan-to-Value (LTV) Ratio?
The loan-to-value ratio is a simple formula that measures the amount of financing used to buy an asset relative to the value of that asset. It also shows how much equity a borrower has in the home they’ve borrowed against—how much money would be left if they sold the home and paid off the loan. LTV is the inverse of a borrower’s down payment. For example, a borrower who provides a 20% down payment has an LTV of 80%.
LTV is important because lenders can only approve loans up to certain ratios—80% for Fannie Mae and Freddie Mac loans, for example. If your LTV is too high, your loan may not be approved. Or, you may have to purchase mortgage insurance, which protects your lender in case you default on the loan and the lender has to foreclose.
What Is a Good LTV?
What constitutes a good LTV generally varies by the type of asset being financed. When buying a home, an LTV of 80% or under is generally considered good—that’s the level you can’t exceed if you want to avoid paying for mortgage insurance. To achieve an 80% LTV, borrowers need to make a down payment of at least 20%, plus closing costs.
While 80% is considered adequate, conservative homeowners may want even lower LTVs to reduce their monthly payments or try to qualify for better interest rates.
How to Calculate LTV?
To calculate your loan-to-value, all you need to do is to find the total amount borrowed against an asset. Then, divide that total by the appraised value of the property being financed.
LTV = Loan amount / Property value
It’s also important to keep in mind that the loan amount may include certain expenses that lenders let borrowers finance instead of paying upfront at closing, like loan document preparation and filing fees, for example. However, those expenses do not contribute to the property value—so they increase your LTV.
How LTV Affects Your Ability to Get a Home Loan?
To get approved for a home loan, it’s generally good to plan to make a down payment of at least 20% of the home’s value—this would create an LTV of 80% or less. If your LTV exceeds 80%, your loan may not be approved, or you may need to purchase mortgage insurance to get approved.
LTV is also important because, if you’re buying a home and the appraised value of the home turns out to be substantially lower than the purchase price, you may need to make a larger down payment so that your LTV doesn’t exceed limits set by your lender.
If you already own a home and are thinking about taking out a home equity line of credit (HELOC), most lenders will let you borrow up to 90% of your home’s value, when combined with your existing mortgage. If the value of your home has fallen since you purchased it, you may not even be able to get a home equity loan or HELOC.
Let’s say you own a home that you bought five years ago and is worth $100,000. If you have a mortgage with an outstanding balance of $65,000, that means that your current LTV is 65%. If your credit is good and you qualify for additional financing, you may be able to borrow up to an additional $25,000 through a HELOC, bringing your total LTV up to 90%.
Lastly, if you already have a loan and your home value drops such that your LTV exceeds your lender’s limits, that’s usually not a problem, as most home loans aren’t callable, meaning the lender can’t demand repayment before the end of the loan term. But some HELOCs are. Or, if the term of your HELOC is almost up, your lender may choose not to extend it. If you have a balloon mortgage, you may have trouble refinancing your balloon payment at the end of your loan.
LTV Vs. Combined LTV
While a loan-to-value ratio measures the amount borrowed against a house relative to the value of a house, combined LTV measures the total amount borrowed—across multiple loans—against the value of a house. This is important because, while many lenders only include primary mortgages in their LTV calculations, combined LTV includes the total amount borrowed in any loan secured by the property, including first and second mortgages, home equity lines of credit, and home equity loans.
Loan-to-Value Rules for Different Mortgage Types
Every lender and loan type has its limits and restrictions, including for borrowers’ LTVs. Some even have multiple thresholds—an absolute maximum and a maximum required to avoid additional protections such as mortgage insurance, for example.
Conventional mortgages are those that conform to lending standards set by government-backed entities like Fannie Mae and Freddie Mac. These loans represent the majority of all home loans underwritten in the United States. With conventional mortgages, lenders require a maximum LTV of 80% for borrowers who want to avoid buying private mortgage insurance<. If borrowers are willing to buy mortgage insurance—and the lender improves—borrowers may be able to get up to 97% LTV.
Maximum LTVs permitted when refinancing vary based on the type of property being refinanced, whether the loan is a fixed-rate or an adjustable-rate mortgage (ARM) and whether the borrower is doing a standard refinance or a cash-out refi.
FHA loans are loans issued directly by the Federal Housing Authority to homeowners. These loans are specifically designed to encourage homeownership among borrowers who would have trouble affording a down payment for a conventional loan. The maximum loan-to-value allowed under FHA loans is 96.5%.
It’s also worth noting that all FHA loans require borrowers to purchase mortgage insurance as part of the loan program, so borrowers don’t save any money by making larger down payments.
VA loans are government-backed mortgages that are designed specifically for memes of the U.S. military and veterans. Using VA loan programs, eligible borrowers can finance up to 100% of a home’s value. However, borrowers are typically still responsible for paying any fees and other costs at closing that, together with the purchase price, exceed the value of the home.
USDA loans are government-issued loans that are issued directly by the U.S. Department of Agriculture and are meant to help individuals in rural areas afford homeownership. Using the USDA’s home loan programs, home buyers can finance up to 100% of a home purchase price for existing dwellings. For loans on existing homes, the USDA will often even cover “excess expenses” (those that exceed the home’s value), including:
Tax service fee
Homeownership education fee (a class people have to attend to qualify for a USDA loan)
The initial contribution to the escrow. For new dwellings, USDA loans typically have a maximum LTV of 90% to 100%, but excess expenses are not eligible for financing.