When you’re considering buying a new home and working with a lender, you will come across the term Loan-to-Value (LTV) ratio. But, what does this mean and how will it affect your home buying process? Find out below!
What is a loan-to-value ratio?
In simple terms, the LTV ratio is the size of a loan you take out compared to the value of the property. Lenders often use the loan-to-value ratio to help assess the risk in a potential loan; the higher the ratio, the greater the implied risk to the lender. The lower the LTV ratio, the more attractive is the loan and borrower to the lender.
How is the loan-to-value ratio calculated?
To calculate a loan-to-value ratio, a lender divides the amount of a loan into the total value of the property securing the loan. For example, if someone borrows $325,000 to purchase a house valued at $450,000, the LTV ratio is $325,000/$450,000, or 72%.
Why does it matter?
As the home buyer, it’s important to understand that the higher the risk for the lender, the more it will affect your loan interest rate and available loan programs. 80% LTV tends to be the magic number when it comes to home loans with the lowest interest rate, fees and costs.
If you are unable to secure 20% or more of a down payment, this makes your loan a higher risk. Even so, you can still get approved. There are loan programs available up to 97% LTV. These typically have a slightly higher interest rate and additional monthly costs like mortgage insurance. All are factored together to make sure that your affordability is still intact.