Loan to Value Ratio
A Loan to value ratio (LTV) tells you how much of a property you own – and how much you’re borrowing. The ratio is used for several types of loans, including home and auto loans (both purchases and refinances).
The LTV ratio is calculated by dividing the amount of your loan into the total value of your asset.
Example: assume you want to buy a home worth $100,000. You have $20,000 available for a down payment, so you will need to borrow $80,000. Your LTV ratio will be 80% because the dollar amount of the loan is 80% of the value of the house. $80,000 divided by $100,000 equals 0.80 (which is the same as 80% – see how decimals and percentages are related).
Calculate the LTV ratio by dividing the loan value into the property value: 80,000/100,000 = 0.8.
An easy way to calculate LTV is to use your device’s calculator, or search Google using the slash (“/”) for division. For example, the following link will “search” for the answer:80,000/100,000, or you can type that into any search box (including Bing and Yahoo).
Why it Matters
A LTV ratio helps lenders evaluate risk: the more they lend, the more risk they’re taking. If you’re calculating LTV, you’re probably dealing with a loan that is secured by some type of collateral.
When you borrow money to buy a home, the loan is secured by a lien on the house (the lender can take possession of the house and sell it through foreclosure). The same is true of auto loans – your carcan be repossessed if you stop making payments.
Lenders don’t want your property – they just want to get their money back quickly. If they only lend up to 80% (or less) of the property’s value, they can sell the property at less than top-dollar to recover their funds. Likewise, whatever you bought might have lost value since you bought it, so lending 100% or more puts lenders at risk.
Finally, when you’ve put some of your own money into a purchase, you’re more likely to value it and keep making payments. You’ve got skin in the game, so you’re not going to walk away unless you’re out of options.
Good LTV Ratios
What is a good LTV ratio that can help you get approved for a loan? It depends on your lender’s preference and the type of loan. You’ll often have better luck with more equity invested (or a lower LTV ratio): it’ll be easier to get approved – especially if you have less-than-perfect credit and you’ll pay lower interest rates.
With home loans, 80% is a magic number. If you borrow more than 80% of a home’s value, you’ll generally have to get private mortgage insurance (PMI) to protect your lender. That’s an extra expense, but you can often cancel the insurance once you get below 80% LTV. 97% is another magic number. Some lenders allow you to buy with 3% down (FHA loans require 3.5%) – but you’ll pay mortgage insurance, possibly for the life of your loan.
With auto loans, LTVs often go higher, but lenders can set limits (or maximums) and change your rates depending on how high your LTV will be. In some cases you’ll borrow at more than 100% LTV.
Keep in mind: your equity doesn’t have to be in the form of money that you bring to the deal. If you own property (or a portion of the property), your ownership interest can be used as equity. For example, when you borrow against your house with a home equity loan, you’re using your home’s value and effectively increasing your LTV ratio when you get a loan. If your home gains value because housing prices rise, your LTV will decrease (although you might need an appraisal to prove it).
LTV ratios are extremely important. But they’re part of a bigger picture, which includes:
- Your credit scores (with good credit it’s easier to get higher LTV loans)
- Your income available to make monthly payments
- The asset that you’re buying (is it a house in good shape or a used vehicle?)
In addition to your credit, one of the most important things for lenders is your debt to income ratio. That is a quick way for them to figure out how affordable any new loan will be – can you comfortably take on those extra monthly payments, or are you getting in over your head? Learn more about debt to income ratios.