LTV otherwise known as loan to value ratio, is one of the factors that many lenders use to determine the risk of a loan. It tells how much your borrowing compared to the value of the asset. The higher it is, the more risk the lenders taking on by letting you borrow money and this might translate into higher interest rates, fees, or costs for the loan itself.
LTV indicates what percentage of the purchase you are financing with an asset secured loan. It's how much protection the lender has on the value of the property. Lenders will use this loan to value ratio to determine the risk of a loan, however, it is not the only factor. A high LTV signifies more risk because if the borrower defaults on the loan, the lender may not get enough money by repossessing and reselling the asset to cover the remaining loan amount. The condition of the property, credit score, and credit history also play a huge factor in the lender's risk upon allowing you to borrow money. [Source]
How to determine the loan to value ratio:
To calculate the loan to value ratio, divide the loan about by the value of the asset. For instance, if the home is priced at $350,000 and a borrower puts down $300,000, the loan to value ratio is 85.71%. This may or may not be enough depending on the type of loan you choose. FHA, conventional or traditional loans, and VA may have different requirements for the loan to value ratio percentage. Most conventional loans need that loan to value ratio lower than 80%. The more a borrower puts down, the less risky they become. Borrowers also will receive a lower interest rate the more money they put down.
This can be a difficult thing to accomplish for first-time homebuyers. There are a lot of options for coming up with the down payment for first-time borrowers but for those who are repeat buyers, chances are they should have enough in the equity of their first home to put a substantial down payment on their next. If you have good credit and good credit history, this can mitigate some of the risks a lender takes on with a high loan-to-value ratio loan.
So how does it affect loan terms?
The loan-to-value ratio will have the greatest impact on your mortgage. If your LTV is higher than 80% you may be required to pay additional private mortgage insurance, which can cost between .3% and 1.5% of the total loan. That could be an extra $50 or $300 added to your monthly mortgage payment. This private mortgage insurance will stay on until the property reaches a loan to value ratio lower than 80% or in some cases, 78% come or you can refinance and request to be removed in the future.
If you owe more on your home than it is currently worth that means your loans LTV exceeds 100%, also called negative equity. It can be extremely tough to sell a home unless you have enough cash to pay the difference. In this case, short sales are usually a better option.
For more information on LTV and to find out if the home you are looking at is within the right LTV for your situation give us a call.