What is a Loan to Value Ratio and How to Calculate It
How Much of Your Home Do You Really Own?
A loan to value (LTV) ratio describes the size of a loan you take out compared to the value of the property securing the loan. Lenders and others use LTV's to determine how risky a loan is. A higher LTV ratio suggests more risk because the assets behind the loan are less likely to pay off the loan as the LTV ratio increases. For that reason, the ration is also often used for approving loans or requiring mortgage insurance.
Put another way: the LTV ratio tells you how much of a property you truly own compared to how much you owe. The ratio is used for several types of loans, including home and auto loans (both purchases and refinances).
How to Calculate
To calculate an LTV ratio, divide the amount of a loan into the total value of the asset securing the loan.
Example: Assume you want to buy a home worth $100,000. You have $20,000 available for a down payment, so you will need to borrow $80,000.
Your LTV ratio will be 80 percent because the dollar amount of the loan is 80 percent of the value of the house. $80,000 divided by $100,000 equals 0.80 (which is the same as 80 percent – see how decimals and percentages are related).
Calculate the LTV ratio by dividing the loan value into the property value:
80,000/100,000 = 0.8.
An easy way to calculate LTV is to use your device’s calculator or search Google using the slash (“/”) for division. For example, the following link will “search” for the answer: 80,000/100,000, or you can type that into any search box (including Bing and Yahoo).
Why it Matters
An LTV ratio helps lenders evaluate risk: The more they lend, the more risk they’re taking. Higher risk for the lender means:
- It’s harder to get approved for loans.
- You may have to pay more (with a higher interest rate).
- You may have to pay additional costs, such as mortgage insurance.
If you’re calculating LTV, you’re probably dealing with a loan that is secured by some type of collateral. For example, when you borrow money to buy a home, the loan is secured by a lien on the house. The lender can take possession of the house and sell it through foreclosure if you fail to pay off the loan. The same goes for auto loans – your car can be repossessed if you stop making payments.
Lenders don’t really want your property – they just want to get their money back quickly. If they only lend up to 80% (or less) of the property’s value, they can sell the property at less than top-dollar to recover their funds. That’s easier than holding out for a great offer.
Likewise, whatever you bought might have lost value since you bought it, so lending 100 percent or more puts lenders at risk.
Finally, when you’ve put some of your own money into a purchase, you’re more likely to value it and keep making payments. You’ve got skin in the game, so you’re not going to walk away unless you’re out of options.
Good LTV Ratios
What is a good LTV ratio that can help you get approved for a loan? It depends on your lender’s preference and the type of loan. You’ll often have better luck with more equity invested (or a lower LTV ratio).
With home loans, 80 percent is a magic number. If you borrow more than 80 percent of a home’s value, you’ll generally have to get private mortgage insurance (PMI) to protect your lender. That’s an extra expense, but you can often cancel the insurance once you get below 80 percent LTV. Another notable number is 97 percent. Some lenders allow you to buy with 3 percent down (FHA loans require 3.5 percent) – but you’ll pay mortgage insurance, possibly for the life of your loan.
With auto loans, LTV ratios often go higher, but lenders can set limits (or maximums) and change your rates depending on how high your LTV ratio will be. In some cases, you can even borrow at more than 100 percent LTV.
Underwater: When the LTV ratio is higher than 100 percent, the loan is larger than the value of the asset securing the loan (or you have negative equity). It is typically not a good situation because you’d have to write a check (or pay) to sell the asset – you wouldn’t get any money out of the deal. After home values dropped during the mortgage crisis, underwater home loans were a major problem. Underwater auto loans are always an issue. If you borrow with a high LTV ratio, make sure there’s a good reason for taking the risk.
Keep in mind: Your equity doesn't have to be in the form of money that you bring to the deal. If you own property (or a portion of a property), your ownership interest can be used as equity, and the value of that interest can change over time. For example, when you borrow against your house with a home equity loan, you're using your home's value and effectively increasing your LTV ratio when you get a loan. If your home gains value because housing prices rise, your LTV will decrease (although you might need an appraisal to prove it).
Likewise, if you’re borrowing money to build a new home, you can use the land you’re building on as equity for a construction loan.
LTV ratios are extremely important. But they’re part of a bigger picture, which includes:
- Your credit scores (with good credit it’s easier to get higher LTV loans)
- Your income available to make monthly payments
- The asset that you’re buying (Is it a house in good shape or a multifamily unit? Is it a new or used vehicle? Motorcycle or RV?)
In addition to your credit, one of the most important things for lenders is your debt to income ratio. That is a quick way for them to figure out how affordable any new loan will be – can you comfortably take on those extra monthly payments, or are you getting in over your head?