During the homebuying process, you’re sure to encounter the term Loan-to-Value (LTV) ratio. So what exactly is your LTV ratio, and why is it important?
Simply put, an LTV ratio is the dollar amount of a mortgage divided by the property’s appraised value, expressed as a percentage. For lenders, LTV is an important measure of the risk in a loan: the higher the percentage, the higher the risk. Lenders use LTV as one of several factors in determining whether or not a homebuyer qualifies for a home loan.
For homebuyers, the LTV ratio is an indication of how favorable the specific terms of your mortgage will be such as interest, insurance, and monthly payments.
How to Calculate Your LTV
Want to know how to calculate a loan-to-value ratio? It is actually pretty straightforward equation!
Mortgage Value ÷ Appraised Value = LTV Ratio
LTV Example 1: If you apply for a $90,000 mortgage to purchase a home appraised at $100,000, your loan-to-value ratio is 90 percent.
- $90,000 / $100,000 = 90%
LTV Example 2: A buyer borrows $130,000 to finance a $150,000 home. The LTV ratio is $130,000 divided by $150,000, or 87 percent.
- $130,000 / $150,000 = 87%
Why LTV Is Important
Loan-to-value calculations are used by lenders for both purchase and refinance transactions, and they help to determine your mortgage rate and loan eligibility. The LTV ratio is also used as a tool to approve loans and determine if private mortgage insurance (PMI) is required for the borrower. Banks and lenders typically require that borrowers obtain PMI coverage when the LTV is greater than 80 percent.
LTV for Refinancing
The loan-to-value ratio for refinancing is slightly different: it’s calculated by dividing your home equity (rather than your mortgage amount) by your home's appraised value. This is important to note because if the value of a home increases after the borrower receives a fixed loan, refinancing may result in lower interest rates. If the appraisal value is lower than expected at the time of refinancing, the fixed rate will likely rise since the LTV is higher.
However with certain types of refinances, such as streamline refinancing programs, the LTV requirements can be waived.
What Is a Good Loan-to-Value Ratio?
Generally, lenders prefer a loan-to-value ratio that’s at or below 80 percent. Having a higher LTV ratio doesn’t mean you can’t borrow, and it doesn’t necessarily mean you won’t be approved for a mortgage either. Pennymac can allow LTV ratios up to 97 percent. However, a high LTV does affect the type of loan you qualify for and usually results in a larger total cost of the loan. Conversely, a lower LTV means there’s more equity in the property and, consequently, the interest rate for the borrower is likely to be lower.
Get a Handle on Your LTV
Have further questions about your loan-to-value ratio or how it is used? Want to learn which mortgage or refinancing programs are available to someone with your LTV? Contact a Pennymac Loan Officer to find answers today.