What Is Loan to Value?

Your home’s loan-to-value ratio (LTV) is a measure of the equity you have in your home compared to the principal balance of your mortgage loan. Mortgage lenders use the LTV as part of the risk assessment process when you apply for a loan, and they view loans with a high LTV as a bigger risk. While they might still approve your mortgage, there’s a good chance that it will cost you more in the long run. Before you start shopping for a mortgage, make sure you’ve learned all you need to know about your loan-to-value ratio so you make the best financial decisions.

How Do You Calculate a Loan-to-Value Ratio?

Figuring out your LTV is a fairly simple process; divide your mortgage’s principal balance by the home’s value. The trickiest part of this is determining the current value. Most lenders use the sale price of the home when determining LTV. However, if you paid more for the home than its appraised value, lenders will generally default to the lower appraised value instead of what you paid for the home.

For example, if you purchase a home for $100,000 that appraises at $110,000 and you put down $20,000 and take out a mortgage for $80,000, your LTV is 80 percent (80,000/100,000=.80). If everything else is equal except that the appraised value of that home comes in at $90,000, then your LTV is 89 percent (80,000/90,000=.89).

Can I Get Approved for a Mortgage with a High Loan-to-Value Ratio?

Lenders give the best terms and interest rates to borrowers who put down a minimum of 20 percent on the home. That doesn’t mean, however, that you won’t qualify for a mortgage with a smaller down payment. Lenders of VA and USDA mortgage loans allow up to 100 LTV. You can also get an FHA loan with an LTV of up to 96.5 percent, and you may even qualify for a conventional loan with an LTV of up to 97 percent.

How Does My Loan-to-Value Ratio Impact My Mortgage Payments?

Though LTV plays a role in the mortgage terms a lender offers you, it’s only one piece of the puzzle. Financial lending institutions generally look at the whole picture when making decisions, including your credit score, additional assets and LTV. In the case of most conventional loans, if your LTV is higher than 80 percent, you will be required to carry private mortgage insurance (PMI) until you reach an LTV of 80 percent. PMI usually costs between $30 and $70 for each $100,000 you borrow, and it generally takes several years before you reach the required LTV.

Let’s say that you purchase a home for $200,000 and you only put $10,000 down and take out a $190,000 mortgage to pay the balance. It could take you 93 payments (close to eight years) before you have paid down the balance enough so that you have an 80 percent LTV. If your PMI premium is $119 per month, you would have paid $10,829 before you could stop the PMI on your mortgage.

While the USDA and VA do not require mortgage insurance on their loans, the FHA does. Virtually all FHA loans have a mandatory mortgage insurance premium (MIP) attached to them. The biggest difference between MIP and PMI is that MIP is in place for the life of the loan. The only way to stop the payments is to refinance the mortgage.

When you have a high LTV, in addition to PMI or MIP, you may also find that you are assessed prepaid points on the loan at the closing, or you may find you have a higher interest rate. Whether either of these things happen really depends on your lender and your overall financial situation.

How Can I Lower my Loan-to-Value Ratio?

There are two simple ways to lower your LTV more quickly:

1. Pay an additional amount each month toward your mortgage’s principal balance or made an additional payment each year.
2. Make renovations to your home that will increase its appraised value.

Your LTV will also decrease if the home values in your area naturally increase, which will raise your appraised value.

In the same example as was used before where you pay $200,000 for a home and only put 10 percent down, you wouldn’t reach the required 80 percent LTV until you’ve made 93 payments. If you pay an additional $100 per month toward the loan’s principal, you would reach an LTV of 80 percent after just 70 payments, or less than six years of PMI payments.

What Happens if My LTV Is More Than 100 Percent?

As many homeowners saw during the housing crisis, if your home decreases in value, you could find that your LTV increases to more than 100 percent. When this happens, your mortgage is considered to be upside down. This is not the situation that you want to find yourself in, but if it does happen, it doesn’t mean that all is lost.

There are new programs that have been put into place since the housing crisis to help refinance high loan-to-value mortgages. One of the most common refinance programs for these types of loans is the HARP Refinance program. For FHA loans, homeowners may be eligible for an FHA streamline refinance loan.

Waiting to buy a house until you have a hefty down payment is ideal, but it isn’t always practical. Before you sign a mortgage contract, however, make sure that you’ve assessed how a high LTV  may impact your monthly payments so that you don’t find yourself struggling as you adjust to your dream home.

2 Point Highlight

Lenders give the best terms and interest rates to borrowers who put down a minimum of 20 percent on the home.

Though LTV plays a role in the mortgage terms a lender offers you, it’s only one piece of the puzzle.