Loan-To-Value Ratio Explained

Published on November 2, 2020
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Knowing your loan-to-value ratio 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.

What Is LTV?

A loan-to-value (LTV) ratio is the relative difference between the loan amount and the current market value of a home, which helps lenders assess risk before approving a mortgage. The lower your LTV, the less risky a mortgage application appears to lenders. A low LTV may improve your odds at getting a better mortgage.

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How To Calculate Loan-To-Value Ratios

Loan-to-value ratios are easy to calculate: just divide the loan amount by the most current appraised value of the property. For example, if a lender grants you a \$180,000 loan on a home that’s appraised at \$200,000, you’ll divide \$180,000 over \$200,000 to get your LTV of 90%.

Here’s a more visual representation of the calculation:

LA/APV = LTV ratio

Where LA= Loan Amount and APV=Appraised Property Value

 Prospective Home Appraised property value \$200,000 Loan amount \$180,000 Calculation \$180,000/\$200,000 = 0.9 LTV 90%

In this example, the LTV is fairly high, which signals a higher risk to the lender. A 90% LTV may come with higher interest rates and mortgage insurance.

What's A Good Loan-To-Value Ratio?

An LTV of 80% or lower is an ideal target – not only does this mean you’ll be eligible for preferable loan options with better rates, but you can avoid paying mortgage insurance, saving hundreds of dollars on your mortgage payments.

If your loan-to-value ratio is higher than 80%, that can mean you’ll have to pay for mortgage insurance. Mortgage insurance allows the lender to take greater risks to lend you the money by protecting the lender in case you default on the loan.

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 and mortgage investors take your down payment as one indicator of the risk involved in your loan. From a lender’s perspective, when home buyers invest more of their own funds upfront, lenders will see them as serious and invested borrowers.

Larger down payments also increase equity in the home. For example, if you’ve put \$20,000 down 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 (the better).

Here’s an example of how a larger down payment can decrease your loan-to-value ratio.

 Prospective Home Appraised property value \$200,000 Down payment \$50,000 Loan amount \$150,000 Calculation 150,000/200,000 = .75 LTV 75%

Choose A Less Expensive Home

If you’re unable to 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 a preferable loan option.

Remember, you already have the equation. That 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 improve your LTV ratio.

For example, if you know you only have \$10,000 to use toward a down payment, this is how the price of a home can lower your LTV:

 Home One Home Two Purchase price \$150,000 \$100,000 Down payment \$10,000 Loan amount \$140,000 \$90,000 Calculation 140,000/150,000 = .93 90,000/100,000 = .9 LTV 93% 90%

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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 refinancing. A lower LTV on your home can lead to lower monthly payments.

Let’s look at a few ways to lower your LTV.

Make Regular Mortgage Payments

Making on-time mortgage payments will lower your principal balance (the amount you borrowed) and build your 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 (property value), with the heaviest books on the bottom and will want to keep the top shelf (loan amount) light. The more you pay off your loan and lighten the top shelf, the sturdier the bookshelf, and the more reliable you look to lenders.

At some point, you’ll have paid off enough of your loan to reach an 80% LTV ratio, meeting the 20% down payment requirement. This means you no longer need to pay private mortgage insurance, saving you hundreds of dollars per year.

Build Sweat Equity With Home Improvements

Paying off principal on a loan will lighten the top shelf, but you can stabilize the bottom shelf in an existing home by increasing the property value. Several studies have found that a well-designed landscape can increase property value.

One study found that 68.2% of respondents agreed that a well-designed landscape could influence their decision to rent or buy a home. There are plenty of ways to build sweat equity in your home before you get it reappraised.

Presume Housing Market Shifts

Based on your home’s location and how many people are interested in buying a home, your property value could naturally increase over time as demand increases. Of course, the market could experience a downturn. Before you decide to refinance your mortgage, try using the Federal Housing Finance Agency’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. It could be time to refinance your mortgage to improve your interest rate, take cash out or eliminate PMI.

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 only increases in value over time, there are factors that can make your LTV ratio skyrocket.

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 a decreased property value can affect your loan-to-value ratio.

 Property Variables Original purchase price \$200,000 Property value \$150,000 Loan balance \$175,000 Calculation \$175,000/\$150,000 = 1.166 LTV 117%

When your home loan balance is higher than the value of your home, it’s referred to as an underwater mortgage. This means you owe the lender more than the value of your home. It’s a situation you want to avoid by paying your mortgage and researching the value of comparable homes in the same area.

How LTV Affects Your Mortgage Loan Options

Your LTV plays a role determining what type of mortgage you are eligible for since each loan type has varying rules and requirements for loan-to-value ratios.

Conventional Loans

Conventional loans, like a 30-year fixed or 15-year fixed, are mortgages that are not backed by a government agency like the FHA (Federal Housing Administration) or VA (Department of Veterans Affairs). These loans require borrowers to have a credit score of at least 620 and a debt-to-income ratio (DTI) no higher than 50%.

You can qualify for a conventional loan with an LTV of 97%, requiring as little as a 3% down payment. But by making a down payment of 20% or more, you can avoid paying PMI. This can save you hundreds of dollars on your mortgage payments.

FHA Loans

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 great for borrowers that have a loan-to-value ratio of 96.5% or lower because they require as little as 3.5% down payment. The smaller down payment means you’ll be required to pay mortgage insurance, which you can remove by refinancing to a conventional loan after you have 20% equity in your home.

By having less stringent qualifications and allowing lower down payments, FHA loans are a great choice for first-time home buyers or home buyers with less-than-ideal credit.

VA Loans

VA loans are backed by the Department of Veterans Affairs and are only available to eligible veterans, active duty service members and their 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 full value of their home.

The Bottom Line

Remember, your LTV is only one piece of your mortgage application. The lower your loan-to-value ratio, the lower your interest rates and mortgage insurance is likely to be. Understanding your LTV can help you determine if you’re ready to get a mortgage and show you what home loans are available to you.

Ready to purchase a home? Visit Rocket Mortgage® today to find the right loan option for you.

Apply Online with Rocket Mortgage

Get approved with Rocket Mortgage® – and do it all online. You can get a real, customizable mortgage solution based on your unique financial situation.

Apply Online

Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.