What is Loan to Value Ratio and Its Importance

When you own a home, one of the most important concepts you can understand is loan to value ratio. Your loan to value (LTV) ratio is an expression of the amount of your mortgage as a percentage of the total value of your property. Your loan to value ratio is usually figured on your first mortgage.

financial ratio

How to Calculate the Loan to Value Ratio

Your loan to value ratio is determined by dividing the amount you are borrowing by the appraised value of your home. It’s fairly simple: If you are borrowing $180,000 to purchase a home that is appraised at $190,000, you end up with

$180,000 ÷ $190,000 = 0.9474 x 100 = 94.74%.

Some lenders will round to the nearest whole percentage — in this case 95%.

Your loan to value ratio can also be figured for refinancing purposes. If you plan to refinance your home, you will probably need an appraisal. In this case, your lender will want to figure your loan to value ratio using what you owe on your home, and the new appraisal. If you have been in your home for awhile, and paid down your mortgage to where you owe $150,000 and your home appraises for $190,000, your new loan to value ratio is 78.95%.

How Loan to Value Ratio Affects You

Mortgage lenders use loan to value ratio as a risk assessment tool.

The higher your loan to value ratio, the bigger the default risk you appear to be.

As a result, lenders will take steps to protect themselves.

  • If you are getting your first mortgage, and your loan to value ratio is greater than 80%, you will probably have to pay a higher interest rate.
  • On top of that, you will be required to pay for private mortgage insurance (PMI), which add significant a expense to your loan. If you default, the insurance — you pay the premiums — will protect the lender from loss.

When it comes to refinancing, loan to value ratio can have a similar impact. Many lenders are reluctant to refinance a home that has a high loan to value ratio. You might be denied an application to refinance without a low enough loan to value ratio. If you aren’t denied, you will have to pay a higher interest rate. Most lenders want to see LTV at 80% or less to consider refinancing your mortgage.

Another issue with refinancing is what happens if you have negative equity. The recent real estate market crash means that the appraised value of your home might be lower now than when you bought it. If you borrowed $180,000 in 2007 to purchase a home appraised at $190,000, you might have paid down your mortgage to the point where you now owe $172,000. But your home might have plummeted in value, and is perhaps appraised at $170,000. Now, your loan to value ratio is 101.18%. Unless you can refinance under a government program, you are out of luck in this case.

Bottom Line

Your loan to value ratio can affect how much you ultimately pay in interest. When buying a home, you can reduce your loan to value ratio by making use of a larger down payment. If you know that you will refinance, you can make extra mortgage payments so that you have more equity — or ownership — in your home.

Photo by hans s.

About the Author

By , on May 6, 2013
Miranda is a freelance writer and professional blogger, specializing in financial topics. She has written for a number of financial web sites, and her work has been linked to by many publications, online and off. Miranda's blog is Planting Money Seeds.

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  1. Jose says:

    Your LTV will definitely affect your interest rate on a mortgage, whether it’s a new mortgage or a refi. I recently refinanced and when my appraisal came in lower than expected it raised my LTV, which ended up raising the interest rate by a quarter point,

  2. I wonder how widespread government refinancing is. Sounds like a common problem, especially given the markets in many areas.

  3. krantcents says:

    LTV determines risk. It also identifies how much equity you have.

  4. This is very interesting. I have read about and understood much about what happened in the housing market during the recession, but I didn’t put it into a prospective of loan to value ratio. I understood that the value of many homes declined and therefore the mortgages were often more than the house was worth but I did not know about the ratio. I had heard of it but I hadn’t thought to calculate it.

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