What is a loan-to-value?

Loan-to-value (LTV) is a ratio that is used in mortgage lending. It is one of the metrics that the lender will use to determine whether or not they’re willing to offer credit to a potential investment property buyer. This metric is used to help illustrate how risky a particular mortgage loan would be to offer based on the amount of the loan compared to the value of the property that will be purchased.

LTV ratios are an important aspect in determining the creditworthiness of a borrower.

What does a high LTV mean?

A higher LTV ratio means that the loan is considered to be riskier. It means that the lender is getting less cash upfront. They’re collecting a smaller down payment, so a larger portion of the total value of the property is being lent out. In the event of a default, the lender is taking on a higher risk because they have less cash in their hands upfront. The buyer has less investment property equity until a more substantial amount of payments have been made.

A down payment on a property is typically between 5% to 20% of the purchase price or appraised value of the investment property. If the buyer is making a 5% down payment, then that’s a lower LTV ratio compared to a buyer who makes a 20% down payment on their mortgage.

Why is it riskier for lenders?

Imagine a scenario where a buyer defaults after just a few months or even a few years and the mortgage lender has to sell the property on the market. Investment property prices can fluctuate, neighborhoods can go in and out of style, and other factors can impact a property’s value, too. All of this creates risk. The less of the overall cost of the mortgage that has been paid back at the time of the default, the higher the level of risk that is being carried by the lender.

The mortgage with a higher LTV ratio empowers somebody to own a house when they can’t afford a higher down payment while still recognizing that there’s an increased risk. It’s entirely possible that somebody with a lower LTV ratio, who is deemed a lower risk and who has perfect credit, could run into trouble and end up defaulting on their mortgage. It happens! 

On that same note, people who are deemed to be in the riskiest category of borrowers can make every payment on time for the entirety of their loan without any issues at all. Nonetheless, lenders have to base their rates off of something, so they work with what they have—even if it’s not always possible to predict the future.

What is a good LTV?

If you don’t have a lot of cash on hand to make a big down payment, but you’re tired of paying rent and you want to start contributing money towards equity in a property, then a good LTV ratio is needed to get you into your new investment property.

Having said that, 80% or less is ideal because you’ll get a better rate—you won’t need to spend a lot more money on insurance and you’ll have more equity available sooner should you need to refinance your property in the future.

How is the LTV ratio calculated?

In terms of the various types of formulas and calculations that you may encounter in the world of finance, the LTV ratio is one of the simplest.

To calculate the LTV ratio, take the appraised valuation of the property in question and divide that number by the amount that is borrowed. Express that number in the form of a percentage to get the LTV ratio.

What does a 60% LTV ratio mean?

To put this into an example, if you have a property that’s appraised with a value of $200,000, then in order to hit a 60% LTV, you would need a down payment of $80,000.

What is considered a high LTV?

Anything above 80% is considered a high LTV in the sense that it represents the higher tier of risk that most lenders are willing to take on. It also triggers the need for mortgage insurance.

What is a combined LTV?

A combined LTV is similar to the LTV ratio, but it also factors in things like liens against the property, investment property equity loans that have been taken out, lines of credit, and second mortgages. This isn’t something that a first-time buyer will have to think about, but it could become relevant when it’s time to refinance or if a property owner is considering a second mortgage on their property if there have been other debts taken out against the value of the property.

What about mortgage insurance?

Insurance on a mortgage is tangentially related to the LTV ratio in the sense that insurance is required for higher LTV ratio loans. If the down payment on the property is lower than 20% of the value, then this insurance is a requirement. Lenders will use insurance as a way to help offset the risk when the loan amount is closer to the total value of the property.

What are the other risk factors for lenders?

While the LTV ratio is one of the main factors that lenders use in determining the risk of a particular loan, it’s not the only one. The credit score of the borrower is also a huge factor. It’s not a perfect metric, but it helps indicate if a borrower has a history of using their credit responsibly. Other factors include the term of the mortgage and the location of the property.

These factors can help a borrower get a lower interest rate, which can save a lot of money throughout the length of the mortgage. Seeking out a loan amount for a mortgage that’s within a price range that enables you to have a more favourable LTV ratio means you may end up with a slightly more modest property, but it will save you more than just the lower purchase price. It will also save you a lot of money in interest based on having lower risk factors in the eyes of lenders.

What is the ideal LTV ratio for refinancing?

If you’re already living in your property and you’ve been making mortgage loan payments for a while, then you may be thinking about refinancing in order to gain access to some of the equity in your property. You may be wondering what the ideal LTV is when it comes time to refinance.

The required LTV that lenders will look for when you’re refinancing can vary, but if you want to qualify for a conventional refinance, then you should aim to have at least 20% equity in your property by that point. Again, a LTV that is higher will be more beneficial for you in terms of rates. 

What are the key takeaways?

Let’s recap some of the things we’ve gone over.

  • Higher LTV means higher payments: Assuming the length of your mortgage is the same, a LTV ratio that is higher means that you’ll be making higher payments each month or either weekly or bi-weekly if you choose those payment terms instead. The higher payments are to account for the fact that you’ve made a lower down payment and will be paying more in interest. Both of these factors contribute to higher payments.
  • It’s based on the appraised value: The appraised value of a property is a snapshot of what it is worth at that point in time. This value can change as market conditions change, but your LTV ratio will be calculated using the most recent appraisal of the property in question.
  • It’s just one indicator: The LTV ration is an indication that is used by lenders. It’s not an exact science, but it is still important.
  • It varies by the type of loan: The LTV ratio exists for other types of loans, too. With a car loan, a higher LTV is often acceptable compared to what mortgage lenders will approve because it’s a lower-price item with lower payments and potentially less risk.
  • Mortgage insurance: Regardless of the loan amount, if a down payment of less than 20% or, in other words, when the LTV ratio is below 80%, then mortgage insurance is a requirement.

 

It’s good to have a basic understanding of how all of these things work when you start shopping around for mortgages and a property. It’s easy to get caught up in the details and to become overwhelmed, but that’s why it’s good to find a mortgage company that you trust to handle the details while still having a general understanding on your own. From LTV ratios to every other aspect of buying a property, don’t be afraid to ask when you’re unsure!

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