In the fourth quarter of 2021, the median home sold for just over $408,000.
Could you afford to pay that out of pocket? Probably not. That’s why most homebuyers wind up applying for mortgage loans.
Getting a mortgage can be a long process and lenders look at a lot of factors when deciding whether to approve your application. You also have to go through a similar process when refinancing.
One thing that lenders look for when making a lending decision is the loan-to-value (LTV) ratio of the loan.
What Is a Loan-to-Value Ratio?
The loan-to-value ratio of a loan is how much money you’re borrowing compared to the value of the asset securing the loan. In the case of a mortgage, it compares the remaining balance of your loan to the value of your house. On an auto loan, it compares the balance of your loan to the value of your car.
Lenders use LTV as a way to measure the risk of a loan. The lower a loan’s LTV, the less risk the lender is taking. If you fail to make payments and the lender forecloses, a lower LTV ratio means the lender has a higher chance of fully recovering their losses by selling the foreclosed asset. A higher LTV means more risk the lender loses some money.
Lenders may have maximum LTVs that they’ll approve. For example, FHA loans require at least 96.5% LTV. Conventional loans require at least 97% LTV, but only for the best-qualified borrowers — most require 95% LTV or lower. Your loan’s LTV can have other important impacts on your borrowing experience, including your interest rate and monthly payment.
Calculating the Loan-to-Value Ratio
Because LTV plays a big role in the overall cost of your loan, it’s a good idea to calculate it before you apply.
To calculate the LTV ratio of a loan, you divide the balance of your loan by the value of your home.
The formula is:
(Loan balance / Home value) = LTV
LTV Calculation Example
Imagine that you want to purchase a home that appraises for $300,000. You apply for a mortgage and get approved for a $270,000 loan.
The LTV of that loan is:
$270,000 / $300,000 = 90%
If you choose to make a larger down payment and only borrow $240,000, your mortgage’s LTV will be.
$240,000 / $300,000 = 80%
As you pay down your mortgage or as your home’s value changes, the loan’s LTV ratio moves away from this initial value. Typically, as you pay off your mortgage, the LTV ratio drops.
How LTV Affects Your Mortgage Rates
Lenders use LTV as a way to measure the risk of a loan. The higher the LTV of a loan, the higher its risk.
Lenders compensate for risk in a few ways.
One is that they tend to charge higher interest rates for riskier loans. If you apply for a loan with a high LTV, expect to be quoted a higher interest rate than if you were willing to make a larger down payment. A higher rate raises your monthly payment and the overall cost of your loan.
Another is that lenders may charge additional fees to borrowers who apply for riskier loans. For example, you might have to pay more points to secure an affordable rate, or the lender might charge a higher origination fee. A larger down payment might mean lower upfront fees.
One of the most significant impacts of a mortgage’s LTV ratio is private mortgage insurance (PMI). While PMI does not affect the interest rate of your loan, it is an additional cost that you have to pay. Many lenders will make borrowers pay for PMI until their loan’s LTV reaches 80%.
PMI can cost as much as 2% of the loan’s value each year. That can be a big cost to add to your loan, especially if you have a large mortgage.
LTV Ratio Rules for Different Mortgage Types
There are many different mortgage programs out there, each designed for a different type of homebuyer.
Different programs can have different rules and requirements when it comes to the LTV of a mortgage.
A conventional mortgage is one that meets requirements set by Fannie Mae and Freddie Mac. While these loans are not backed by a government entity, they must meet Fannie or Freddie’s minimum credit score and maximum loan amount thresholds, among other criteria. Otherwise, they can’t easily be repackaged and sold to investors — the fate of most mortgage loans after closing.
Conventional mortgages have a maximum LTV of 97%. That means your down payment will need to equal at least 3% of the home’s value. If your LTV is higher than 80% to begin with, you’ll have to pay PMI until your LTV drops below 78%.
Refinancing your mortgage lets you take your existing loan and replace it with a new one. This gives you a chance to adjust the interest rate or the length of your loan.
Most lenders aren’t willing to underwrite refinance loans above 80% LTV, but you might find lenders willing to make an exception.
Federal Housing Administration (FHA) loans are popular with homebuyers because they allow low down payments and give people with poor credit the opportunity to qualify.
If you’re applying for an FHA loan, the maximum LTV is 96.5%, meaning you’ll need a down payment of at least 3.5%. If the LTV value of your mortgage starts above 90%, you’ll have to pay PMI for the life of the loan. If your LTV is less than that amount, you can stop paying PMI after 11 years.
VA loans are secured by the Department of Veterans Affairs. They’re only available to veterans, service members, members of the National Guard or Reserves, or an eligible surviving spouse.
These loans offer many benefits, including the option to get a loan with an LTV as high as 100%. That means that you can borrow the full amount needed to purchase your home. The only upfront costs you need to pay are the fees associated with getting the loan.
USDA loans, guaranteed by the US Department of Agriculture, are designed to help people purchase homes in designated rural areas. Borrowers also have to meet certain maximum income requirements.
USDA loans can have LTV ratios of 100%, letting borrowers finance the entire cost of their home. The LTV of the loan can exceed 100% if the borrower chooses to finance certain upfront fees involved in the loan.
Fannie Mae & Freddie Mac
Fannie Mae and Freddie Mac are government-backed mortgage companies. Neither business offers loans directly to consumers. Instead, they buy and offer guarantees on loans offered by other lenders.
Together, the two companies control a major portion of the secondary market for mortgages, meaning that lenders look to offer loans that meet their requirements.
For a single-family home, Freddie Mac has a maximum LTV of 95% while Fannie Mae sets the maximum at 97% for fixed-rate loans and 95% for adjustable-rate mortgages (ARMs).
Limitations of LTV
There are multiple drawbacks to the use of LTV ratios in mortgage lending, both for borrowers and lenders.
One disadvantage is that LTV looks only at the mortgage and not the borrower’s other obligations. A mortgage with a low LTV might seem like it has very little risk to the lender. However, if the borrower has other debts, they may struggle to pay the loan despite its low LTV.
Another drawback of LTV is that it doesn’t consider the income of the borrower, which is an essential part of their ability to repay loans.
LTV ratios also depend on accurate assessments of a home’s value. Typically, homeowners or lenders order an appraisal as part of the mortgage process. However, if a home’s value increases over time, it can be difficult to know the home’s actual worth without ordering another appraisal.
That means that you might be paying PMI on a loan without realizing that your home’s value has increased enough to reduce the LTV to the point that PMI is no longer necessary. You can always order another appraisal, but you’ll have to bear the cost — typically around $500 out of pocket.
LTV vs. Combined LTV (CLTV)
When looking at a property, lenders often use combined loan-to-value (CLTV) ratios alongside LTV ratios to assess risk.
While an LTV ratio compares the balance of a single loan to the value of a property, CLTV looks at all of the loans secured by a property and compares them to the home’s value. It’s a more complete way of assessing the risk of lending to someone based on the value of the collateral they’ve offered.
For example, if you have a mortgage and later get a home equity loan, CLTV compares the combined balance of both the initial mortgage and the home equity loan against your home’s appraised value.
LTV Ratio FAQs
Loan-to-value ratios aren’t easy to understand. If you still have questions, we have answers.
What Is a Good LTV?
What qualifies as a good LTV ratio depends on the situation, the loan you’re applying for, and your goals.
An LTV over 100% is pretty universally seen as bad because you wouldn’t be able to repay your loan even if you sold the collateral asset.
In general, a lower LTV ratio is better than a high LTV ratio, especially if you want to avoid paying for PMI on top of your mortgage loan payment.
The 80% threshold is a particularly important breakpoint, especially for conventional loans. If you have an LTV of 80% or lower, you can avoid PMI on conventional mortgages, saving hundreds of dollars per month early in the life of your loan. At 80% LTV, you’ll qualify for a good interest rate, though dropping to 70% or even 60% could drop your rate further.
How Can I Lower My LTV?
There are two ways to lower the LTV of your mortgage: pay down your mortgage balance or increase the value of the property.
Your loan’s LTV will naturally decrease as you make your mortgage payments. You can speed up the process by making additional payments to reduce your balance more quickly.
If you make improvements to your home, it can increase your home’s value. Real estate prices may also rise in your area, bringing your home’s value up too. However, to formally update the value of your home, you’ll need to pay a few hundred dollars to get it appraised again.
What Does a 50% LTV Ratio Mean?
A 50% LTV ratio means that you have 50% equity in your home. In other words, the total loan balance secured by the home — whether it’s a first mortgage, home equity line of credit (HELOC), home equity loan, or some combination of the three — is half the appraised value of the property.
As an example, your loan-to-value ratio is 50% if your home is worth $200,000 and you still owe $100,000 on your mortgage.
What Does a 75% LTV Ratio Mean?
A 75% LTV means that your loan balance is three-quarters of your home’s value. For example, if your home is worth $200,000 and your remaining mortgage balance is $150,000, your LTV is 75%.
LTV ratio is one way that lenders look at the risk of making a loan based on the value of the collateral securing it. In the real estate world, LTV is a very important measure because it impacts things like private mortgage insurance and mortgage interest rates.
If you’re looking to avoid paying PMI or trying to get out of paying PMI on your loan, you’ll want to take steps to lower your mortgage’s LTV ratio. You can do this by investing in home improvements that increase the value of your home, then ordering a professional appraisal, or by paying extra principal each month to reduce your mortgage balance faster.