The Loan-to-Value (LTV) Ratio Explained

October 10, 2013 | By Brandon Cornett | © 2020, QualifiedMortgage.org

When shopping for a mortgage, you will eventually encounter the term loan-to-value ratio, or LTV. This term is often used when describing the requirements for a certain type of mortgage program or product. For example, FHA loans have a maximum LTV ratio of 96.5%. Conventional (non-FHA) mortgages with an LTV above 80% typically require private mortgage insurance, which is an added cost for the borrower.

So loan-to-value ratios are important to you, the borrower, for two reasons:

  1. They play a role in whether or not you can qualify for a mortgage.
  2. They also determine whether or not you have to pay for mortgage insurance.

Below, you will find a thorough explanation and definition of this topic.

Mortgage Loan-to-Value Ratio Explained

Definition: The mortgage loan-to-value ratio is simply a comparison between (A) the amount of money you are borrowing, and (B) the value of the home you are purchasing. LTV ratios are typically expressed as a percentage. The percentage shows how much of the property value the mortgages will cover.

Calculation: To calculate loan-to-value ratio, you would divide the loan amount by the appraised value or purchase price, whichever is less. If I’m using a $300,000 mortgage to buy a $400,000 house, my LTV ratio is 75%. (The math: 300,000 √∑ 400,000 = 0.75, or 75%)

That’s the definition of loan-to-value ratio. But why is this number so important to lenders? How does it affect you when applying for a mortgage loan? Here’s what you need to know:

LTV Ratios Affect You in Two Ways

As mentioned earlier, LTV ratios can affect you in two ways. They can limit your financing options, and they can also determine whether or not you need mortgage insurance on your loan.

Generally speaking, any mortgage with a loan-to-value ratio greater than 80% will require some form of insurance. This is true for both conventional and government-backed FHA loans.

A conventional mortgage with an LTV above 80% (or, inversely, a down payment below 20%) will typically require private mortgage insurance, or PMI. All government-insured FHA loans require insurance, because FHA borrowers typically put down less than 20% of the purchase price.

Generally speaking, there is an inverse relationship between the loan-to-value ratio and the borrower’s down payment. For instance, a borrower who makes a 20% down payment when buying a home will have an LTV ratio of 80%. In this scenario, the home buyer is covering 20% of the purchase price, and the lender is covering the remaining 80%. So the LTV is 80%.

Low Down Payments for FHA and VA

Certain types of loans offer 100% financing. This means the borrower does not have to make a down payment at all. For instance, the VA home loan program offers 100% financing. In this scenario, the loan-to-value ratio can be up to 100%. The borrower puts nothing down, so the lender covers the entire purchase amount.

The FHA mortgage program allows LTV ratios up to 96.5%. This is what makes the program so popular among home buyers. According to HUD Handbook 4155.1, “for purchase transactions, maximum LTV is 96.5% (the reciprocal of the 3.5% required investment).” This means the borrower can make a down payment as low as 3.5% of the purchase price, when using a government-insured FHA loan.

Conclusion and Summary

This article explains the loan-to-value ratio used in mortgage lending. It offers a basic definition of LTV and explains how it relates to you as a borrower. Here’s a recap:

  • The LTV ratio is a comparison between the amount being borrowed and the lesser of the purchase price (for home buyers) or the appraised value (for homeowners who are refinancing).
  • You can calculate it by dividing the loan amount by the purchase price or appraised value.
  • Loan-to-value ratios influence your ability to qualify for certain mortgage products or programs.
  • They also determine whether or not you will have to pay mortgage insurance, which can increase the size of your monthly payments.
  • Home loans with an LTV above 80% typically require some form of insurance.

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