What is loan to Value? Lending money is a risky business, and lenders today look very closely at a person’s financial health before granting a loan. Lenders’ greatest concern is the loan going into default and losing their investment. To help avoid this, they look at the loan amount in relation to the fair market value of the property being purchased. Loan to value (LTV) is an equation by which the lender can assess how much risk he is taking by lending the money. The higher the loan to value ratio, the higher the cost will be to the borrower. The LTV helps determine the cost of the mortgage.
Let’s say you want to borrow $160,000 to purchase a home selling at $180,000. The LTV ratio is 89%. This would be a high risk loan for the lender. If the homeowner defaults on the loan and the home goes into foreclosure, the lender takes the loss—the larger the loan, the stricter the guidelines. Mortgage insurance is a way the lender has of protecting himself from default, and the higher the loan, the higher the insurance rate. The LTV lets the lender know that if the owner defaults, he will be able to recover his money by selling the house.
Loans above an 80% loan to value ratio are considered high risk. Higher LTVs are given to people with excellent credit scores and clean mortgage histories. Financing at 100% is unusual. Equity is the remainder of the LTV equation—if the value of the loan is 80%, equity in the home is 20%. Equity is ownership in the home. It increases as the mortgage is paid down and through appreciation in value. The owner has full equity in the home when the mortgage is fully paid.
The value of the home is determined through an appraisal. The lender needs to know if the home is actually worth the amount being loaned. Appraisers are licensed professionals and their job is different from the home inspector. The inspector checks plumbing, heating and air conditioning units as well as the overall condition of the interior. The appraiser determines how much the home is worth. His report includes the condition and size of the home, the improvements that have been made, and any structural issues such as a faulty foundation. He compares other sales in the area and may include photos and maps. The area around the home is also taken into to consideration. Nearby property that has been developed (or will be developed) can impact the appraisal. Lenders are reluctant to loan more than the appraisal value.
Purchasing a home is often a stressful experience, but going into it armed with knowledge, like what is loan to value, can help reduce the stress and give you confidence. Knowing your loan to value equation is important. There are many loan to value calculators online. Enter the amount of your mortgage request and the property value, and the calculator will tell you the LTV. Remember that the lower the ratio of loan to value, the lower the risk will be to the lender, and the higher the loan to value ratio, the higher the risk.