Loan-to-Value Ratio

Loan-to-value ratio is a calculation of how much you are trying to borrow for a mortgage in relation to the appraised value of a property. Loan-to-value ratio is used to determine your interest rate on a loan, and whether you need to take out private mortgage insurance.

What is a loan-to-value ratio?

Your loan-to-value (LTV) ratio is the percentage of a home’s value you’ll need to borrow after you’ve determined your down payment. If you put in a 20% down payment, your LTV is 80%; if you put down 10%, your LTV is 90%, and so on. 

How to Calculate LTV?

Loan amount ÷ appraised home value = LTV ratio

The higher the loan-to-value ratio, the more of a risk a borrower poses to a lender. 

What does LTV have to do with risk?

Well, a relationship between a lender and a borrower is based on trust. Lenders loan borrowers money with the expectation that the borrower will pay back the loan in full, with interest.

Let’s say a mortgage has a high LTV, and the borrower defaults on their loan— after which the property goes into foreclosure. Because the down payment was low, the lender runs the risk of losing a lot of money on their investment if the home sells for less than the original appraised value. 

Because of this relationship between lender and borrower, loan-to-value ratio is one of several factors, including credit score and annual income, that determines the interest rate a borrower will have to pay on a loan. The “riskier” the loan is for the lender—the higher the LTV ratio—the higher the interest rate will be for the borrower. 

In addition, borrowers who have an LTV of 80% or higher will often need to take out private mortgage insurance (PMI), which can tack on a couple hundred extra dollars to monthly mortgage payments.

Loan-to-value ratio and mortgage refinancing

If you’re hoping to refinance your existing home loan, your application is more likely to be approved if your LTV is 80% or lower. The lower your LTV, the more likely you are to qualify for a lower interest rate. 

One thing to pay attention to with refinancing is how the value of your property can change over time. 

Let’s say Luna bought a home 10 years ago that was, at the time, valued at $300,000. She paid $50,000 for her down payment, and needed to borrow the remaining $250,000.  Her LTV at the time the mortgage as originated was:

250,000 ÷ 300,000 = 0.83 

LTV: 83% 

It’s been 5 years, and Luna has paid down an additional $50,000 of the loan principal on her mortgage, and she has paid off a total of $100,000 towards her home’s value, making her remaining outstanding loan amount $200,000. 

200,000 ÷ 300,000 = 0.67

LTV: 67%

Now, Luna wants to refinance her mortgage loan to get a lower interest rate. Her home is appraised, and the value has increased to $350,000 — $50,000 higher than the original purchase price. This means that Luna would need to borrow an additional $50,000 on top of her remaining principal balance when she refinances her home. Which means that Luna’s LTV for this refinance is actually: 

250,000 ÷ 350,000 = 0.71

LTV: 71%

Even though Luna’s new appraised home’s value increased her LTV, there’s a good chance she’ll qualify for a lower interest rate by refinancing, since her LTV is still well below 80%. A lower interest rate means Luna can save money on her mortgage payments and potentially pay off her home loan faster. 

Your home can also decrease in value. This isn’t an issue if you want to refinance your home, unless your home’s market value drops below the remaining mortgage balance. This is called being “underwater” on your mortgage.

If this happens, you can seek out government-backed financing solutions, like the Making Home Affordable program, or an FHA Short Refinance.

Loan-to-value ratio and home equity loans

A home equity loan, or home equity line of credit (HELOC), is when a borrower borrows against the value of their home. A borrower’s down payment and their monthly mortgage payments decrease their loan-to-value ratio and increase their equity in their home over time—in other words, as equity increases, the borrower “owns” more of the home, and the lender owns less of it. 

Borrowers might choose to use some of their built-up equity to fund home improvement projects or pay off high-interest debt. Borrowers might do this because chances are, a home equity loan or HELOC will come with a lower interest rate than alternative financing, like a personal loan.

Conditions to take out a home equity loan vary by lender, but in most cases the borrower will need to have at least 15-20% equity in their home (so an LTV of no more than 80-85%) to qualify. 

So, how much can you borrow from home equity? 

The percentage of a home’s value that the borrower still owes in outstanding mortgage or home equity loan payments is called the “combined loan-to-value ratio” (CLTV). Your home equity loan and your outstanding mortgage payments usually cannot exceed 85% of the value of your home. 

So, let’s say Luna wanted to take out a home equity loan. 

The value of her home is $350,000.

85% of $350,000 = $297,000 — this is the maximum amount of Luna’s home value that can be tied up in mortgage and home equity loans. 

Since Luna still owes $250,000 on her mortgage, she has to subtract that amount from the 85% value of her home to figure out how much equity she can borrow. 

$297,000 (85% CLTV) – $250,000 (remaining mortgage balance) = $47,000 (maximum amount of available equity) 

So, Luna would potentially be able to borrow as much $47,000 in home equity loans to do things like build a deck in her backyard, or pay off high-interest student debt.

Loan-to-value ratio on FHA loans

Home loans backed by the Federal Housing Administration (FHA) have more lenient requirements when it comes to loan-to-value ratio than conventional mortgage loans. FHA loans try to help people with lower credit scores, and other people who might not qualify for conventional mortgages, become homeowners.

FHA loans are especially popular with first-time homebuyers. If a borrower has a credit score of 500 or higher, borrowers can qualify for a mortgage with an LTV as high as 90%.  Borrowers who have an LTV of over 90% will need to have a credit score of at least 580. 

FHA loans also come with a requirement to carry FHA mortgage insurance, which will likely need to be paid for the lifetime of the loan.

Loan-to-value ratio on VA loans

The U.S. Department of Veterans Affairs (VA) offers home loans to veterans and their families—with reduced interest rates and no down payment required. Instead of a down payment, borrowers are instead required to pay a one-time funding fee in order to offset the costs of VA loans on taxpayers. The funding fee ranges from 0.50% to 3.60% of the total loan amount. 

Borrowers seeking a VA loan might still choose to put in a down payment on their VA loan in order to reduce their funding fee.