What Is Loan to Value and How Is It Calculated?

A loan-to-value ratio (LTV) compares the amount of money you’re borrowing to the home’s value and then expresses it as a percentage. What is loan to value used for by lenders? It’s one piece of criteria financial institutions look at when assessing whether you’re a good risk for the loan you’re applying for. When the LTV is high, it makes the deal a bit riskier for the lender. While you still might get the mortgage you need, the lender may impose higher interest rates or other fees to offset the risk.

How Do I Calculate My Loan-to-Value Ratio?

Figuring out your LTV is simple. Divide the amount of money you’re seeking for a mortgage and divide it by either the home’s purchase price or the appraised value of the property, depending on the lender. For example, if you’re buying a home for $200,000 and you’re making a down payment of of $25,000, then your LTV is 88 percent. Since most financial institutions prefer the LTV to be 80 percent or less, the loan might cost you more than you anticipated.

What Is a Combined Loan-to-Value Ratio (CLTV)?

A combined loan-to-value ratio comes into play when you apply for a second mortgage or home equity line of credit. Instead of just using the amount of the loan you’re applying for, your bank will add the principal balance of your current mortgage to the potential loan before doing any calculations.

If you own a home that appraises for $175,000 and your principal balance is $125,000, then your LTV is 71 percent, which makes you a good risk in the eyes of your lender. When you apply for a $20,000 line of credit, the bank adds the $125,000 and the $50,000 together and then divides it by your home’s appraised value of $175,000. This makes your CLTV 83 percent, which is slightly higher than lenders like to see.

Can I Get a Mortgage With an LTV of Greater Than 80 Percent?

Lenders use 80 percent as the highest LTV they like to see, but you may still qualify for a mortgage even if your LTV exceeds that magic number. The Federal Housing Administration offers FHA mortgages to borrowers with an LTV of up to 96.5 percent, and if you qualify, you can get a VA or USDA loan with an LTV of up to 100 percent, which means you won’t have to make a down payment. If you’re going for a conventional loan, you may be able to qualify with an LTV of up to 97 percent.

What Are PMI and MIP?

When you apply for a conventional mortgage with a loan-to-value ratio of more than 80 percent, your lender will probably require you to pay private mortgage insurance (PMI) premiums. Though there are a lot of variations, PMI will generally cost you between 0.5 and one percent annually of your mortgage balance. On a $175,000 mortgage, this means that your monthly payments may go up by as much as $145.83. The good news is that PMI premiums can stop as soon as your LTV reaches 80 percent.

Since all FHA loans have an LTV of more than 80 percent, you will be required to pay mortgage insurance premiums (MIP). Though the cost is similar to PMI, it’s calculated very differently. Unlike PMI, MIP stays in place for the life of the loan. The only way to stop the premiums is to refinance your mortgage.

What Can I Do If My LTV Is Increasing Instead of Decreasing?

Following the 2008 housing crisis, the government introduced several programs to ensure that the real estate market remained stable. It introduced the HARP program in 2009, which offered borrowers with an LTV of greater than 80 percent the opportunity to refinance with lower interest rates and no PMI premiums. The program also helps homeowners whose mortgages are underwater, which means that the LTV is greater than 100 percent.

HARP has been revised several times since its inception to widen the pool of borrowers who qualified. In order to be eligible for a HARP refinance loan, you must meet the following criteria:

• Your mortgage must be current with no payments more than 30 days past due in the last six months and no more than one past-due payment in the last 12 months.
• The home must eighter be your primary resident, a single-uit second home or an investment property with one to four units.
• Your current loan must be a Fannie Mae or Freddie Mac mortgage.
• Your mortgage’s origination date is on or before May 31, 2009.
• Your current loan-to-value ratio is great than 80 percent.

Though the HARP program is set to expire on December 31, 2016, it’s possible that Congress might step in again to extend the program another year.

What Are the Best Ways to Decrease My Loan-to-Value Ratio?

As you make payments on your mortgage, your principal balance will gradually decrease, which lowers your LTV. For example, if you buy a home for $200,000, put $25,000 down on it and take out a 30-year fixed-rate mortgage of $175,000 at 4.5 percent interest, your initial LTV is 88 percent. After only five years of payments, your principal balance will hit the $160,000 mark, giving you an LTV of 80 percent.

You can speed up the process of reaching an 80 percent LTV by paying a little extra each month toward your mortgage principal. For example, an additional $100 payment each month on your mortgage would help you to reach an 80 percent LTV in less than four years.

An appreciation of home values in your area or home renovations that increase your home’s value may also decrease your LTV. Your bank will most likely require that you pay for an appraisal to back up the new numbers.