If you’re hoping to become a homeowner, you have plenty of numbers swirling in your brain: interest rates, closing costs, property taxes and more. The lender who will review your mortgage application has quite a few figures to consider, too. One of the key numbers is your loan-to-value ratio, or LTV.
What is LTV and how is it calculated?
Your loan-to-value ratio is how much money you’re borrowing, also called the loan principal, divided by how much the property you want to buy is worth, or its value.
For example, if you plan to make a down payment of $50,000 on a $500,000 property, borrowing $450,000 for your mortgage, your LTV ratio — $450,000 divided by $500,000, multiplied by 100 — would be 90 percent.
What about combined LTV?
If you already have a mortgage and want to apply for a second one, your lender will evaluate the combined LTV (CLTV) ratio, which factors in all of the loan balances on the property — the outstanding balance on the first mortgage, and now the second mortgage.
Let’s say you have an outstanding balance of $250,000 on a home that is appraised at $500,000, and you want to borrow $30,000 in a home equity line of credit (HELOC) to pay for a kitchen renovation. Here’s a simple breakdown of the combined LTV ratio:
$280,000 ($250,000 + $30,000) / $500,000 = 56 percent CLTV
If you have a HELOC and want to apply for another loan, your lender may look at a similar formula called the home equity combined LTV (HCLTV) ratio. This figure represents the total amount of the HELOC against the value of your home, not just what you’ve drawn from the line of credit.
Why lenders look at LTV
Before a bank or lender decides to approve your mortgage application, the lender’s underwriting department needs to be confident that you’re going to be able to pay the loan back. Understanding the full scope of the LTV ratio involves more work to determine how you’ll be able to pay for the “L” in the equation.
Julienne Joseph, assistant director of government housing programs and member engagement at the Mortgage Bankers Association, explains that, in addition to LTV, lenders look at a front-end ratio and a back-end ratio to evaluate your finances.
The front-end ratio is known as the “housing ratio,” and it divides your total monthly mortgage payment — principal, interest, taxes and insurance, or PITI — by your monthly income.
Let’s say your monthly mortgage payment is $1,500, and your monthly income is $6,000. Your front-end ratio, in that case, would be 25 percent.
Your mortgage payment isn’t the only cost you’ll be managing as a homeowner, however. Do you have a car loan? Are you paying back loans from college? Consider all the money you owe other lenders for the back-end ratio, also known as the debt-to-income (DTI) ratio, which is the monthly mortgage payment plus all of your other monthly debt obligations divided by your monthly income.
If your monthly mortgage payment is $1,500, your monthly income is $6,000 and your monthly debt obligations total $1,300, your back-end or DTI ratio would be 46 percent.
“High DTI ratios signal to lenders that the borrower has a lower share of their income available to cover unexpected expenses, which may lead to hardship or default of the mortgage,” Joseph says.
Between the LTV and the front- and back-end ratios, if the lender deems you a greater risk, you’ll likely pay a higher interest rate, which translates to paying more money over the life of the loan.
“Loans with higher LTV ratios generally are considered to entail greater risk, because a lender is more likely to lose money on them should the borrower go into default and the proceeds from a foreclosure sale aren’t able to cover the outstanding balance of the mortgage to the investor and court costs,” Joseph says. “To mitigate the potential loss on these loans, lenders may assess a price adjustment to the interest rate.”
What is a good LTV ratio?
Ideal LTV ratios vary depending on the lender and the type of loan.
|Loan type||LTV maximum|
|*Without private mortgage insurance (PMI)|
- Conventional loan – The magic LTV ratio for most lenders is 80 percent. This means you can afford to make a 20 percent down payment, and as a borrower, you won’t have to pay private mortgage insurance.
- FHA loan – Generally, an LTV ratio of 96.5 percent will suffice for securing an FHA loan. Keep in mind that the minimum 3.5 percent down payment requirement for FHA loans means you’ll need to pay mortgage insurance.
- VA loan – If you’re a service member or veteran, you can have a 100 percent LTV ratio with a VA loan (in other words, no down payment), provided you meet other requirements for approval.
- USDA loan – Available to low- and moderate-income homebuyers in rural areas, the United States Department of Agriculture gives certain borrowers the ability to get approved with a 100 percent LTV ratio, as well.
- Refinancing – If you’re considering refinancing your mortgage, most lenders will want to see an LTV ratio of 80 percent or lower (at least 20 percent equity).
“Typically, lenders prefer loans with lower LTV ratios, but acknowledge that many borrowers are unable to provide a significant down payment,” Joseph says.
How to lower your LTV
Lowering your LTV ratio can happen one of two ways: You can save more money to make a larger down payment on your dream property, or you can find a cheaper property.
If you find a $250,000 home, for instance, instead of the $500,000 one in the previous scenario, a $50,000 down payment will give you an 80 percent LTV ratio, which can help eliminate the additional cost of mortgage insurance and put you much closer to paying off the loan from day one.
You can determine how much house you can afford using Bankrate’s calculator.