One of the many aspects involved in the purchase of a property is the loan-to-value ratio or LTV. LTV plays a significant role in mortgage approval and the terms offered to borrowers. REALTORS® can benefit from being well-versed in LTV to ensure smooth and informed client transactions.

What Is Loan-to-Value (LTV) Ratio?

Loan-to-value (LTV) ratio is a fundamental metric in real estate financing. It represents the relationship between the loan amount and the appraised value of a property. Lenders use the LTV ratio to assess the risk of a mortgage because a lower LTV ratio indicates less risk.

L​​TV ratio is calculated by dividing the mortgage loan amount ​​​​by the appraised value and is expressed as a percentage. Here’s the formula:

LTV = (Mortgage Amount ÷ Appraised Property Value) x 100

Homebuyers and real estate professionals can easily calculate LTV ratio to make projections. For example, a home is listed for $310,000 and appraised for $300,000. If the buyer puts $70,000 down and seeks a loan of $240,000, the loan-to-value ratio is 80% ($240,000 ÷ $300,000 = 0.8 x 100), even if the selling price is $310,000.

Loan-to-Value Ratio Thresholds

Loan-to-value ratio thresholds vary and have important implications for borrowers, especially when considering whether home buyers will need to purchase private mortgage insurance (PMI). Here are some typical LTV ratio thresholds and their related mortgage products:

  • ​​​70% LTV: Considered low risk, requires a ​​30% down payment, and may not require PMI.
  • 80% LTV: Considered low risk, requires a 20% down payment, and may not require PMI.
  • 90% LTV: Considered high risk, requires a 10% down payment and may require a PMI.
  • 95% LTV: Considered high risk, requires a 5% down payment and may require a PMI.
  • 97% LTV: ​​Ideal for low-income borrowers, considered high risk, requires a ​​3% down payment and a PMI.
  • ​​​100% LTV: VA and USDA loans require no down payment but require mortgage insurance and other fees.

These value brackets are usually expressed in 5% intervals. A higher LTV percentage indicates a higher risk for lenders, potentially resulting in higher interest rates for the borrower, and a lower LTV indicates a lower risk for lenders, typically qualifying the borrower for lower interest rates.

LTV Ratio and Mortgage Approval

A buyer’s loan-to-value ratio significantly influences mortgage approval decisions. Higher, riskier LTV ratios will affect the mortgage terms the borrower can secure. For example, a high LTV ratio might require PMI and a larger down payment.

Assessing Borrower Risk

Lenders use LTV ratios to evaluate borrower risk. A lower LTV ratio entails less risk for the lender, often resulting in more favorable terms, such as lower interest rates and fewer stringent loan conditions. On the other hand, high ​​LTV ratios (above 80%) often require private mortgage insurance (PMI), stricter loan terms, and higher interest rates.

In high LTV ratio transactions, title insurance provides additional protection for both lenders and borrowers ​​by safeguarding against ownership disputes and other title issues.

Loan Eligibility and Terms

Loan-to-value ratios influence not only mortgage approval but also the terms offered. Borrowers with lower LTV ratios typically qualify for a broader range of loan products with better terms. For example, a buyer with an 80% LTV ratio or lower may qualify for conventional loans without PMI, whereas a borrower with a 95% LTV ratio may need to seek FHA loans with PMI.

Down payment assistance for FHA loans and first-time home buyer loans & grants can also play a crucial role in improving a borrower’s LTV ratio, allowing them to qualify for better loan terms.

Interest Rates

Even small increases in interest rates can significantly affect monthly payments and the total interest paid over the life of the loan. For example, a borrower with an 80% LTV ratio may secure an interest rate of 3.5%, whereas a borrower with a 95% LTV ratio will likely secure a rate closer to 4.5%.

A 1% difference in interest rate could mean an ​​additional $33,000 in interest over the lifetime of a $160,000 loan.

In short, the higher the LTV ratio, the greater the risk to the lender, which translates to higher interest rates.

Down Payment Requirements

The loan-to-value ratio is the difference between the property value and the loan amount. This ​​excludes closing costs. The lower the down payment, the greater the LTV ratio. For instance, an 80% LTV ratio on a $250,000 property requires a 20% down payment of $50,000, whereas a 97% LTV ratio for the same property requires only a 3% down payment of $7,500.

REALTORS® can guide their clients in saving for a down payment based on their financial position, explaining the mortgage benefits of a larger down payment.

LTV, DTI (Debt-to-Income Ratio), and Other Metrics

While the LTV ratio is critical to the lender’s decision, they also consider other financial metrics, such as the debt-to-income (DTI) ratio. ​​DTI ratio measures a borrower’s debt load relative to their income and is calculated using the formula DTI = Total Monthly Debt Payments ÷ Gross Monthly Income.

Lenders also consider ​​other metrics, such as credit score, the type of loan, assets, and employment history, along with LTV and DTI, to have a comprehensive understanding of borrower risk. Lower credit scores, as well as higher LTV ratio and DTI, affect a buyer’s eligibility for better loans and lower interest rates.

How to Calculate LTV

Using the formula LTV = (Mortgage Amount ÷ Appraised Property Value) x 100 is straightforward. For example, a first-time ​​home buyer wants to determine their LTV ratio for a home valued at $400,000 with a down payment of $40,000 (10%). They seek a mortgage for $360,000.

  • Mortgage amount: $360,000
  • Property value: $400,000
  • LTV ratio: ($360,000 ÷ $400,000) x 100 = 90%

LTV for the same property with a down payment of $12,000 (3%) is calculated as follows:

  • Mortgage amount: $388,000
  • Property value: $400,000
  • LTV ratio: ($388,000 ÷ $400,000) x 100 = 97%

​​​In competitive markets, REALTORS® can advise clients on how earnest money or a “good faith deposit” can be applied toward the down payment.

Avoiding Errors in LTV Calculation

Errors in LTV calculations can cause significant issues in real estate transactions. REALTORS® and home buyers should be cautious of making common mistakes, including:

  • Assuming their first calculation is correct.
  • Using an incorrect or outdated appraised value.
  • Not accounting for all the buyer’s outstanding loans, such as home equity lines of credit (HELOCs).
  • Misunderstanding the appraisal process.
  • Forgetting to recalculate their LTV after refinancing.

These mistakes could hinder the buyer’s trust in their agent, as well as pass up opportunities to buy a home more suited to the home buyer’s financial position, among other consequences.

Final Thoughts: LTV in Real Estate

When guiding clients on purchasing or selling property, REALTORS® must understand LTV ratios to provide accurate, insightful guidance. By mastering LTV ratio calculations, REALTORS® can assist clients in securing favorable mortgage terms, improving their overall home purchase experience, and even providing a first glance into what value brackets would be most advantageous to them during consultations.