The euphoria of being ready to buy your first home is quickly washed away when you start trying to navigate the complex terms and calculations associated with getting approved for your loan. 

While you'll come across a range of acronyms, understanding the term loan-to-value (LTV) ratio is essential to help you secure the best rates and terms for your loan. So, what exactly is LTV?

Keep reading to learn more about this crucial metric that directly impacts your mortgage options.

TLDR Key Takeaways

• In a nutshell, a loan-to-value ratio is a financial measurement that compares your home's value versus the total amount of your loan.
• The lower your LTV, the happier lenders are because it means you have more equity in the property.
• LTVs higher than 80% typically will have to pay Private Mortgage Insurance (PMI).

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

A loan-to-value ratio calculates the relationship between a loan amount and the appraisal value of a property. In other words, it helps lenders determine whether or not the borrower has enough equity in the property to use as collateral to secure the loan.

It's just another way for mortgage lenders to ensure their investment is protected should the borrower run into financial difficulties during repayments.

Loan-to-value ratios come into play when buying a house, refinancing a current mortgage, or borrowing against a property's equity.

The higher the LTV, the risker the loan is to the lender because if something happens to the borrower, the lender must resell the property to recoup their money. An unfavorable change in market prices makes this difficult.

On the other hand, a lower LTV is viewed as less risky, which, coincidentally, often results in better borrowing terms. But what exactly constitutes a low LTV? Generally speaking, LTVs of 80% or less are considered low.

Pro Tip: Down payments, sales prices, and appraised values all affect your overall LTV ratio. Higher down payments and lower sales prices result in the lowest LTV ratio.

How LTV Affects Your Mortgage

While several factors like your credit score, income, and debt-to-income (DTI) ratio influence your eligibility for a mortgage, your LTV also plays a critical part in the lender's underwriting process. 

As we mentioned before, most lenders tend to favor borrowers with a low LTV and will reward them with competitive terms. That doesn't mean they won't have 95% LTV programs available, but these will come with very stringent requirements. 

On top of having to jump through additional hoops, borrowers looking to secure a loan with a higher LTV will typically have:

• Higher Interest Rates: It's common for lenders to charge higher interest rates (up to a full percentage or more) to recoup their capital faster.
• Private Mortgage Insurance (PMI): This adds 0.5 to 1% to your loan every year. For instance, a 1% PMI on a $100,000 loan would result in an additional $1,000 in annual payments.
• Limited Options: Borrowers may only have access to a small number of repayment options and terms.
• Difficult Approval Process: Lenders will want to look at your finances with a fine-toothed comb to ensure you won't default on your loan, and even then, they may require additional assets or collateral before they approve the loan.

If you want to get the best terms and rates, then you'll want to try and lower your LTV.

How to Calculate Your Loan-to-Value Ratio

To calculate your LTV, you'll need to divide the loan by the value of the property or asset. The formula below represents the equation:

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

For example, if you were looking to buy an investment property worth $500,000 and secured a loan for $400,000, your LTV would be 80%. Here's how that would look:

LTV (80%) = (MA ($400,000) ÷ APV ($500,000)) x 100

What Is a Good LTV?

The lower your LTV ratio, the better. But typically, many lenders require a loan-to-value ratio of at least 80% to approve most loans. With an 80% LTV or less, you increase your chances of a successful application and get better interest rates.

 Quick Tips to Improve Your LTV Ratio

Making smart financial decisions is key to improving your LTV and gaining better access to more favorable mortgage options. Here are a few quick tips to help you improve it:

Maximize Your Downpayment

Your down payment directly influences your LTV. The more money you have to put down, the lower your LTV will be.

Try to set aside as much money as possible each month into savings so that you can increase the amount of money available to use as a down payment. 

Wait for the Market to Change

We all know that the housing market fluctuates from year to year, even season to season. Paying attention to market trends can help you decide when the best time to start house hunting is. 

If you wait for prices to go down, you can afford the home of your dreams with more favorable terms. 

Pay Down Existing Debt

High levels of debt negatively impact your loan-to-value ratio because they reduce the amount of money available to you to use as a down payment. Try to pay down or eliminate any outstanding debt so you can free up money to apply to a down payment.

Make Extra Payments on Your Principal

If you're looking to refinance your home, you'll want to make sure you lower your LTV before reaching out to your lender. Remember, with every mortgage payment, your LTV ratio decreases. An extra installment per year will further reduce your LTV ratio.

Different Types of LTV Rules

When it comes to LTV ratio requirements, different loan types may have different rules.

FHA Loans

These mortgages, facilitated by FHA-approved lenders and backed by the Federal Housing Administration (FHA), offer qualifying low-to-moderate earners a secure financing alternative while allowing them access to competitive interest rates.

FHA loans are an ideal option for those looking to maximize the purchasing power of their income, as the down payment requirement and credit score requirements are lower than those for conventional loans. 

FHA loans offer generous initial loan-to-value (LTVs) of 96.5%; however, it is important to note that this advantage comes at the cost of carrying mortgage insurance for the duration of your loan.

To mitigate this, many people refinance their FHA loans as soon as their LTV ratio reaches 80%.

VA and USDA Loans

Current and former military members and individuals who live in rural areas can take advantage of VA and USDA loans. 

There is no PMI requirement for these loans, and loan values can reach 100%; however, each of these loans comes with additional fees.

Fannie Mae and Freddie Mac

Low-income borrowers can obtain mortgages with 97% LTV through Fannie Mae's HomeReady and Freddie Mac's Home Possible programs. They do, however, require mortgage insurance until the ratio reaches 80%.

For owners looking to refinance their home loan, FHA, VA, and USDA loans offer simplified options that waive appraisal requirements, providing homeowners the opportunity to access refinancing relief without costly appraisals standing in the way.

For homeowners who have taken on more debt than their property is worth, Fannie Mae ( High Loan-to-Value Refinance) and Freddie Mac (Enhanced Relief Refinance) both offer specialized refinancing programs to help.

What's the Difference Between LTV and Combined LTV (CLTV)?

LTV and CLTV are powerful tools for assessing the financial implications of mortgages on a property. LTV ratios measure the impact of a single mortgage loan on a property, while CLTVs take into account all loans that are secured to that same property, including:

• Primary mortgage 
• Second mortgage(s)
• Home equity loan(s)
• Lines of credit
• Other liens

By measuring individual loan values, as well as all outstanding loans secured to it, these ratios provide valuable insight into a prospective home buyer's risk of default when they have more than one loan. 

For example, if they have multiple mortgages and a home equity loan or line of credit (HELOC), the CLTV may indicate too much risk.

While 80% and above is a common CLTV benchmark, some lenders tend to be more flexible, although they will most likely have stronger thresholds for borrowers to cross.

Flexible Lending Options for Any LTV

With so much jargon and terms associated with mortgages, it can be easy to get overwhelmed with the process. One wrong move could cost you thousands of dollars in interest charges or even cause you to lose your dream home.

But it doesn't have to. With the right partner, you can successfully navigate the mortgage application process and secure financing for your dream home.

At Modern Day Lending, we make it our mission to provide you with personalized loan assistance that gives you the best terms for any LTV. We'll help you evaluate all of your options and determine which is best suited to your individual needs.

Our two decades of experience and wide-ranging network of investors and financial institutions enable us to provide customized mortgage solutions for individuals from all walks of life, from entrepreneurs and self-starters to seasoned investors. 

Schedule a consultation with our mortgage experts and get the optimal deal tailored to your specific needs.