Loan-To-Value Ratio (LTV), Explained
Knowing your loan-to-value ratio (LTV) better prepares you for a home purchase or refinance. When you borrow money to buy a home or refinance your mortgage, lenders will compare the amount you’re borrowing against the value of the property. That percentage helps determine which type of loan you can get and what your interest rate will be.
We’ll go over what LTV is, how to calculate it, how to improve your LTV and more.
What Is Loan-To-Value Ratio?
Loan-to-value ratio is the relative difference between the loan amount and the current market value of your home expressed as a percentage. LTV is a common measurement that helps lenders make decisions when issuing loans.
LTV also helps lenders assess a borrower’s ability to afford a mortgage. And a low LTV may improve your odds of getting a better mortgage.
How To Calculate Loan-To-Value Ratios
Loan-to-value ratios are easy to calculate. Just divide the loan amount by the current appraised value of the property. For example, if a lender gives you a $180,000 loan on a home that’s appraised at $200,000, you’ll divide $180,000 over $200,000 and get an LTV of 90%.
Written out, the formula looks like this:
Loan Amount / Appraised Property Value = LTV Ratio
Here is our example broken down into steps:
- First, you’ll need to know your loan amount and appraised property value. In this example, your loan or mortgage amount is $180,000, and the appraised property value of the home you're buying is $200,000.
- Next, you’ll plug the numbers into the formula: $180,000 / $200,000 = 0.9
- To express your result as a percentage, multiply it by 100: 0.9 ✕ 100 = 90%.
In this example, the LTV is fairly high, which may signal to the lender that you may struggle to cover your existing bills and a new mortgage.
When it comes to mortgage loans, you’ll need to make decisions regarding down payments based on your personal financial situation. It’s important to be aware that a higher LTV would likely result in higher interest rates and would require mortgage insurance.
What's A Good Loan-To-Value Ratio?
An LTV of 80% or lower is a good target LTV. With an 80% LTV, you’ll be eligible for preferable loan options with better rates and avoid private mortgage insurance (PMI) insurance, potentially saving money on your mortgage payments.
If your loan-to-value ratio is higher than 80%, you’ll likely pay for PMI, which protects your lender in case the loan ever goes into default.
How To Improve Your LTV Ratio On A New Home
Whether you’re buying a new home or refinancing, there are ways you can improve your loan-to-value ratio.
Make A Larger Down Payment
When buying a home, making a larger down payment will lead to a lower LTV. Lenders take your down payment as an indicator of your seriousness to purchase a home and your financial stability.
Larger down payments also increase the equity in your home. For example, if you make a $20,000 down payment on a home appraised for $100,000, your LTV on an $80,000 loan will be 80%. The larger the down payment, the smaller your LTV ratio – which is better.
Here’s an example of how a larger down payment can decrease your loan-to-value ratio:
- Let’s say the appraised property value of a home is $200,000, and you decide to make a $50,000 down payment. That means you’ll need a loan for $150,000.
- Next, you’ll plug in the numbers into the LTV ratio formula (Loan Amount / Appraised Property Value = LTV Ratio): $150,000 / $200,000 = .75
- To express your result as a percentage, multiply it by 100: 0.75 ✕ 100 = 75%
Let’s take a look at two example side by side to see the difference a large down payment can make:
10% Down Payment
25% Down Payment
Appraised property value
180,000 / 200,000 = .90
150,000 / 200,000 = .75
Choose A Less Expensive Home
If you can’t make a larger down payment and are on a strict budget, the other option is to focus on less expensive homes. This will lower your LTV and might help you get preferable loan options.
Understanding the LTV equation means you can manipulate the variables (appraised property value and loan amount) to get a lower, preferable LTV. Finding a home with a lower appraised value will lower your LTV ratio and help you get the key to a home that’s a better fit for your budget.
Let’s say you’ve saved up $10,000 for a down payment. Using the examples in our table, you’ll be able to see how the price of a home can lower your LTV:
140,000 / 150,000 = 0.93
90,000 / 100,000 = 0.9
How To Improve Your Loan-To-Value Ratio For Refinancing
If you own a home, improving your LTV is a worthwhile goal if you’re planning to refinance. A lower LTV on your home can lead to lower monthly payments.
Let’s look at a few ways to lower your LTV for a refinance.
Make Regular Mortgage Payments
Making your monthly mortgage payments on time will lower your principal balance (the amount you borrowed) and build your home equity. It can be helpful to think of the ratio as a bookshelf, where the top shelf is the loan amount and the bottom shelf is the property value.
Any sturdy bookshelf will be bottom-heavy (the property value). The heaviest books will be on the bottom, and you’ll want to keep the top shelf (the loan amount) light. The more you pay off your loan and unburden the top shelf, the sturdier the bookshelf will become, and the more reliable you’ll look to lenders.
As you make your monthly payments, your equity will increase, and your LTV will improve. If you’re paying private mortgage insurance, you can have it removed once you reach an 80% LTV ratio.
Having a lot of equity in your home has several benefits, including the likelihood of lower refinance rates and the ability to tap into your home equity through a cash-out refinance or home equity loan.
Increase The Market Value Of Your Home With Sweat Equity
Paying off the principal on a loan will lighten the top shelf, but you can better stabilize the bottom shelf of your home by increasing its property value.
One way to increase your home’s value is to make exterior improvements that improve your curb appeal. Simple do-it-yourself projects, like maintaining your landscaping or installing a porch swing, could increase your home’s value and a potential buyer’s interest in your home. If you’re a savvy DIYer, there are plenty of ways to build sweat equity in your home before it’s appraised by a professional.
Presume Real Estate Market Shifts
Based on your home’s location and how many people are interested in buying a home, your property’s value could naturally increase over time as demand increases. Of course, the market could experience a downturn. Before you decide to refinance your mortgage, use the Federal Housing Finance Agency’s (FHFA’s) House Price Calculator to see how homes in your area have appreciated in value.
With a lower loan-to-value ratio, you may qualify for a loan you weren’t eligible for when you purchased your home. A lower LTV gives you more options when you’re ready to refinance your mortgage to lower your interest rate or use your equity to take cash out of your home.
Factors That Can Worsen Loan-To-Value Ratios
Of course, owning a home takes work and a bit of housing market luck. While homeownership is generally an investment that increases in value over time, some factors can make your LTV ratio increase.
Decrease In Property Value
Your property can decrease in value if the home is not maintained over time or if the housing market drops dramatically. When this happens, your LTV rises.
Here’s an example of how decreased property value can affect your loan-to-value ratio:
- Let’s say the home’s appraised property value was $200,000 when you purchased it, and your loan amount was $175,000. However, due to market changes, the appraised property value dropped to $150,000.
- Your loan amount hasn’t changed, but the value of your property has, and it will negatively impact your LTV. To see the effect, let’s plug the new numbers into the LTV formula (Loan Amount / Appraised Property Value = LTV Ratio): $175,000 / $150,000 = 1.166
- To express your LTV as a percentage, multiply the result by 100: 1.166 = 117%
When your home loan balance is higher than the value of your home, you have an underwater mortgage. This means you owe the lender more than your home is worth.
Other factors that could result in an increased LTV are converting your home equity into cash through a cash-out refinance, a second mortgage or a home appraisal that incorrectly estimates the value of the home you are buying.
Paying your mortgage on time and doing market research on comparable homes in your area before you buy can help you avoid an underwater mortgage. Other steps you can take include making sure to use a reputable appraisal company and only taking out equity when it’s necessary or to increase your home’s value.
How LTV Affects Your Mortgage Loan Options
Your LTV plays a role in determining what type of mortgage you are eligible for since each loan type has varying rules and requirements for loan-to-value ratios.
Conventional mortgage loans, like a 30-year fixed or 15-year fixed, are not backed by a government agency, like the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA). Conventional loans require borrowers to have a credit score of at least 620 and a debt-to-income ratio (DTI) no higher than 50%.
The minimum down payment for a conventional loan is 3%, which means you can qualify for a conventional loan with an LTV of 97%. But if you can make a 20% down payment or more, you’ll avoid paying PMI.
FHA loans are home loans backed by the Federal Housing Administration. They require a credit score of 580 or higher to qualify.
FHA loans are helpful for borrowers with a loan-to-value ratio of 96.5% or lower because the minimum down payment requirement is 3.5%. The smaller down payment means you’ll be required to pay mortgage insurance, which you can remove by refinancing to a conventional loan once you have 20% equity in your home.
Because FHA loans have less stringent loan requirements and allow borrowers to make lower down payments, FHA loans are a great choice for first-time home buyers or home buyers with less-than-ideal credit.
VA loans are backed by the Department of Veterans Affairs and are only available to eligible veterans, active-duty service members and surviving spouses.
Compared to other mortgage loan options, VA loans make it easier to buy or refinance a home. VA loans are available with an LTV ratio of 100%, allowing service members to buy a home with zero down or refinance the entire value of their home.
The Bottom Line
Remember, your LTV is only one part of your mortgage application. The lower your loan-to-value ratio is, the lower your interest rate and mortgage insurance are likely to be. Understanding your LTV can help you determine whether you’re ready to get a mortgage (or refinance) and help clarify which home loans are available to you.
Ready to get started on buying a home? Find out what you qualify for today.