One of the critical ways lenders evaluate the risk of a mortgage for a home purchase or refinance is to look at its loan-to-value (LTV) ratio. This figure compares how much you’re borrowing with the property’s value, helps determine which loan type you’re eligible for and affects what interest rate you’ll be offered. Learn more about calculating an LTV and how it affects your chances of getting a home loan.
What Is LTV Ratio?
Loan-to-value ratio is a percentage that compares the value of the mortgage you need to buy a home (or refinance your current one) and the appraised value of the home.
LTV ratios help lenders assess a borrower’s ability to afford a mortgage when buying a house. The lower your LTV ratio is, the less you borrow against the home’s value. This usually corresponds in reverse to the down payment: A higher down payment reduces the LTV ratio.
“When the LTV ratio is low, it means the lender is less exposed to risk, hence offering the borrower better rates and improved chances of getting the loan,” says Andy Kolodgie, co-founder of Property Leads, a real estate investment website based in Sheridan, Wyoming.
Loan-To-Value Ratio Vs. Combined Loan-To-Value Ratio
Some borrowers have more than one mortgage secured by their home, such as a home equity loan or home equity line of credit (HELOC).
A combined loan-to-value ratio, or CLTV ratio, considers the balance of all loans secured by your home.
Let’s say you own a home worth $400,000 and have a mortgage with a balance of $200,000 and a HELOC with a balance of $50,000. Your primary mortgage’s LTV ratio is 50%, and the HELOC’s LTV ratio is 12.5%. The total debt is $250,000, which results in a CLTV ratio of 62.5%.
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How To Calculate Loan-To-Value Ratio
Understanding how to perform a loan-to-value calculation on your own will help you navigate the home-buying process. LTV ratios are easy to calculate: Divide your loan balance by the appraised value of your property, and multiply the result by 100 to get a percentage.
For instance, imagine you’ve just begun the process of shopping for a house. You find one you like and discover that its appraised value is $500,000. Your lender approves you for a $480,000 loan.
To find your LTV ratio in this case, you would first divide $480,000 by $500,000, giving you a value of 0.96. Next, you’d multiply that value by 100 to get a percentage: 96%.
A loan-to-value calculation can help you determine whether you can reasonably afford a house. The LTV ratio is the percentage of the home’s value covered by your mortgage, and the remaining percentage determines the amount of your down payment.
Going back to the example above, you know that because your LTV ratio is 96%, your down payment would need to be 4% of the home’s total value of $500,000. That means you would need a down payment of $20,000 and your mortgage would cover the rest.
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Why Do Mortgage Lenders Use Loan-To-Value Ratio?
Every time a lender offers a prospective home buyer a mortgage, they’re taking a risk. If the borrower is unable to make their mortgage payments and the mortgage goes into default, the lender may not get their money back. Consequently, if a lender sees a home buyer as a risk, they’ll likely charge a higher interest rate.
Look at it from the lender’s point of view. Imagine someone who wants to borrow $195,000 to buy something worth $200,000. They don’t have much skin in the game, so you’re taking more of a risk. If they ask to borrow $100,000, the buyer has more invested and the lender is taking on less risk and is therefore more likely to approve that loan.
If the LTV ratio is very high, a lender may reject a home buyer’s application. If the LTV ratio is low enough for approval but high enough to indicate a major risk, the lender will likely try to offset that risk by doing the following:
- Charging an interest rate that’s higher than average
- Requiring the buyer to obtain private mortgage insurance
Some loan types have maximum LTV ratios, meaning you can’t qualify if you don’t have sufficient home equity. Federal Housing Administration loans set a maximum LTV of 96.5%, meaning you need a down payment of at least 3.5% of the home’s value.
When Do Lenders Require Private Mortgage Insurance (PMI)?
Private mortgage insurance is a policy that reimburses your lender if you default on your loan. If you have a high LTV ratio (meaning you’ve made a relatively low down payment), your lender may require you to pay for PMI.
For conventional loans, you typically have to pay for PMI if your LTV ratio is more than 80%, meaning you’ve made a down payment of less than 20% of the home’s value. Your LTV ratio will decrease as you pay down your mortgage balance and if your home’s value appreciates. Most lenders will cancel PMI when your LTV drops to 78% or at the midpoint of your loan’s repayment schedule.
Keep in mind that your lender will calculate the LTV ratio using the most recent appraised value of your home. If you believe your home has increased in value, you can request – and usually must pay for – a new appraisal.
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Comparing Loan-To-Value Ratio By Loan Type
Different loan types require different LTV ratios. Generally, the less risk a lender faces, the higher the borrower’s LTV ratio can be.
Conventional loans, which aren’t insured by the government, require a lower LTV ratio unless you have an excellent credit score. Government loan programs, such as the FHA, U.S. Department of Agriculture and Veterans Affairs loan programs, are insured, allowing lenders to take greater risks and approve loans with a higher LTV ratio.
Non-conforming loans aren’t backed by the government. One of the most common types of non-conforming loans is the jumbo loan. A jumbo loan exceeds the Federal Housing Finance Agency (FHFA) loan limit.
Because non-conforming loans don’t have government backing, lenders take on a much higher risk. To help offset that risk, they’ll often set a lower maximum loan-to-value ratio, meaning borrowers must make a larger down payment.
Maximum LTV Ratio By Loan Type
| Loan Type | Maximum LTV Ratio |
|---|---|
| Conventional Conforming Loan | 97% |
| Jumbo or Nonconforming Loan | Varies by lender, often 80% or lower |
| FHA Loan | 96.5% |
| VA Loan | 100% |
| USDA Loan | Greater than 100% as the guarantee fee can be financed in addition to 100% of the home’s value |
| Refinance | 95% |
| Cash-Out Refinance | 80% |
Tips For Lowering Your LTV Ratio
Lowering your LTV ratio can help you qualify for a better rate and avoid PMI payments. Here are some tips for reducing your LTV ratio quickly, whether you’re buying a new home or refinancing.
How To Improve Your LTV Ratio For A New Home
If you’re buying a new home, there are some ways you can improve your loan-to-value ratio:
- Make a larger down payment:The bigger your down payment is, the less you’ll have to borrow from your lender, resulting in a lower LTV ratio.
- Choose a less expensive home:Imagine you have $20,000 for a down payment on a home. The less expensive the home is, the further that money will go when reducing your LTV ratio. If you buy a $400,000 home, you’d need to borrow $380,000, giving you an LTV ratio of 95%. But if you found a $200,000 home, you’d only have to borrow $180,000, and your LTV ratio would decrease to 90%.
- Apply for a piggyback loan:Some lenders will let you apply for piggyback loans, which are additional mortgages – usually a home equity loan or HELOC – in addition to your primary loan. Often, these are used to finance a down payment, letting you avoid PMI. Because the LTV ratio looks only at the balance of your primary mortgage, piggyback loans will reduce your LTV ratio. However, they do count toward your CLTV ratio.
- Choose a shorter loan term: This won’t reduce your LTV ratio immediately, but if you choose a loan with a shorter term, you’ll reduce your LTV ratio faster. Shorter terms lead to larger monthly loan payments and a faster reduction in loan principal, speeding up the process of building equity and lowering your loan’s LTV ratio.
How To Improve Your Loan-To-Value Ratio For Refinancing
Even if you already own a home, improving your LTV ratio is a worthwhile goal if you’re planning to refinance. A lower LTV ratio can lead to lower monthly payments.
It can be helpful to learn how to reduce your LTV ratio before refinancing:
- Make regular mortgage payments: Paying your mortgage on time lowers your principal and builds equity. The further you get in your repayment schedule, the more quickly your LTV ratio will fall, as more of each payment goes toward the principal.
- Boost your home’s value: If your home gains value, your LTV ratio will fall even if your loan balance stays unchanged. If you put in some legwork to improve your home’s curb appeal or utility, you can increase its value. 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.
- Wait for the real estate market to shift: Home values tend to rise over time. If you wait, your home could gain value and reduce your LTV ratio. Of course, there’s always a risk that values will drop, so before you refinance your mortgage, use the FHFA’s House Price Calculator to see if homes in your area have appreciated in value.
Loan-To-Value Ratio FAQ
If you’re able to choose a more affordable home, your down payment will make up a larger percentage of the home’s value, automatically lowering your LTV. Similarly, because a shorter loan term involves paying less interest over time, your LTV will drop quickly.
The Bottom Line
Your LTV ratio is only one part of your mortgage application. That being said, the lower your LTV ratio is, the lower your interest rate will be and the more likely you will be to avoid PMI payments. Understanding your LTV ratio can help determine whether you’re ready for a mortgage and clarify which home loans are available.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
