Ever wonder how much a lender’s willing to bet on your new house or truck? Well, that’s where the loan-to-value ratio comes in. It’s how the lender keeps from getting a pig in a poke!
The LTV ratio sizes up how much of the lender’s money you will be using compared to what that shiny new thing you’re buying is actually worth.
Loan-to-value (LTV) is the ratio between the loan amount and the appraised value of an asset.
The higher the LTV, the more you’re leaning on the lender’s wallet, which could make it a little nervous about getting the money back. Keep reading. I’ll explain the basics of the LTV ratio, how it affects loan approval and terms, and how you can achieve the best one possible.
Loan-to-Value Ratio Basics
Understanding the LTV ratio is like knowing how much water is in the pool before diving in. It’s important in lending because it tells lenders just how deeply they’ll be committed when they decide to toss you a loan.
How Your LTV Ratio is Calculated
Let’s start by defining the terms in the LTV ratio. The amount lent is the quantity that you’re asking the lender to hand over, plain as day. The appraised value is what the lender thinks a house, car, or whatever asset you’re buying is really worth.
It’s a formula that goes like:
LTV = (Loan Amount / Appraised Value) x 100
To find the LTV, you take the loan amount and divide it by the appraised value of the property or asset. Then you multiply by 100, so you have a nice, clean percentage.
The ratio tells the lender whether it’s taking its fair share of the risk or climbing out on a limb.
Let’s look at an example from our old pal Jane. She wants to purchase a house that appraises for $400,000, and she’s seeking $320,000 in a mortgage loan. The LTV for Jane is calculated by dividing $320,000 by $400,000, getting a result of 0.8. Times that by 100, and we get an 80% LTV. Jane is borrowing 80% of the value of the home.
Spoiler alert: she got the loan and loves the house.
Why Lenders Look at the LTV Ratio
Lenders keep close tabs on the LTV ratio because that’s how they calculate how much risk there is in lending you money. The higher the LTV, the greater the lender’s potential for loss if things go bad and you find yourself unable to pay.
That’s why a high LTV may have lenders thinking twice before saying yes or smacking you with higher interest rates. In other words, the LTV ratio helps lenders decide whether they are driving the car or holding onto the bumper.
If your LTV is low, you have more to lose by defaulting on the loan, so the lender can breathe a little easier and offer better loan terms. However, if your LTV is high, the lender is taking on more of the risk, so don’t be surprised if it charges you extra to cover its own backside.
How LTV Ratio Impacts Approvals and Terms
Understanding the way in which your LTV ratio affects loan approvals and their terms can make a huge difference when trying to make a big-ticket purchase.
Loan Approval
Many lenders have an LTV maximum, which acts like a cap — you have to meet the requirement to satisfy the lender and get a loan. Think of it like the load limit on a bridge — they won’t let you cross if your LTV ratio is too high because they’re worried the bridge (or, in this case, the loan) might collapse under the strain.
Not every lender has the same requirements regarding LTV ratios. Some, like big banks, may have a relatively strict LTV requirement in order to keep their own risk as low as possible. On the other hand, smaller or more lenient lenders — such as credit unions or certain online lender — may be a little more lenient and allow for a higher LTV ratio.
But no matter who you’re dealing with, keeping your LTV ratio in check helps you qualify for the loan you’re after. More flexible lenders will grant a little more leeway, but it’s always a good idea to try and aim for a lower LTV to boost your chances of approval.
Interest Rates
A low LTV may result in a lower interest rate since you’re not asking the lender to take on as much risk. The less the lender has to fret over, the more likely they are to give you a break on interest, thus saving you real cash over the long term.
For example, suppose you have two prospective homebuyers, Bill and Sue. Bill’s LTV ratio is 70%, whereas Sue’s sits at an unsettling 90%. Since Bill borrows less of the home’s value, his lender sees less risk and offers him an interest rate of 4%. Sue has a high LTV ratio, so her lender charges her 6% to cover this extra risk. Over time, that difference in interest rate adds up to a whole pile of money.
The moral of the story? If you want to keep more money in your pocket rather than handing it over to the lender in the form of higher interest, then keep your LTV ratio low.
Down Payments
Lowering your LTV ratio is done by making bigger down payments. The more you put down upfront, the less you have to borrow, and that brings the LTV ratio down. This makes you look better financially to the lender.
With a lower LTV, you may even qualify for better loan terms, such as a lower interest rate or better repayment options.
Let’s take, for instance, Jim and Ann. Ann is able to put 30% down on her new house, which brings her LTV ratio down to 70%. Jim can only manage to do a 10% down payment, leaving him with a 90% LTV. Since Ann’s LTV is much lower, her lender gives her a better interest rate and more lenient terms, while Jim ends up paying way more over the life of her loan.
So, make your life easier: Try to scrape together a bigger down payment. Your LTV ratio will go down, and you’ll be a more attractive borrower. You are interested in saving money over the life of the loan, right?
Common Types of Loans With LTV Ratio Requirements
If you are fixing to borrow money, you better know what different types of loans there are and what sort of LTV ratio each of them expects from you. Some loans may be a bit more lenient, whereas others won’t budge. Knowing what’s what can save you from the heartbreak of disapproval when you really need a loan.
Mortgages
Lenders can be pickier than a chef in a produce aisle when it comes to LTV ratios for mortgages. Lenders enforce different maximum LTVs depending on what kind of mortgage you’re after.
Qualifying Mortgages
A qualified mortgage is just your regular, straight-and-narrow loan that follows all the rules that Fannie Mae, Freddie Mac, and the Dodd-Frank Act set. It means you’re able to afford monthly home payments, have a stable income and good credit, and are at low risk of default. Lenders are quite comfortable making qualifying mortgages.
- Conventional loan: A conventional mortgage will usually require you to have an LTV of 80% or lower, meaning that you need to put down some pretty substantial money upfront.
- FHA loan: If you’re dealing with a Federal Housing Administration (FHA) loan, you could get by with an LTV of 96.5% because this type of mortgage is for people with smaller down payments.
- VA and USDA loans: Veterans Administration (VA) and US Department of Agriculture (USDA) loans are an entirely different story. Most of these enable you to go up to a 100% LTV, which means you may borrow the whole purchase price without having to scramble for a down payment.
It’s not all gravy, though. These lenders still want to be certain that you can make the payments, so they’ll also check other boxes, such as your credit score and income.
Regardless of whether you’re after a conventional, FHA, VA, or USDA loan, having an idea of what the LTV requirements are may save you from wasting time applying for a loan beyond your reach. The more you understand these numbers, the better chance you’ve got at securing that dream home without hitting a snag.
Non-Qualifying Mortgages
Non-qualifying mortgages are loans that don’t play by the usual rules set by Fannie Mae and Freddie Mac. They represent the wild card of the mortgage deck, custom-tailored for an individual who doesn’t fit the mold of a typical borrower. They have become a staple for the self-employed, real estate investors, or anyone with an unconventional income source.
Non-QM loans are way more flexible when it comes to proving your income. You may be able to get by with bank statements or other assets to show you can manage the payments instead of using W-2s or tax returns. Non-QM loans are pretty good options if you cannot check all of the boxes but nevertheless have the means to repay your loan.
But here’s the catch: Because these loans don’t play by the book, lenders often charge higher interest rates, demand larger down payments, and slap on tighter LTV limits.
Still, if you have the dough but don’t fit into the conventional loan category, a Non-QM loan may be just the ticket. These loans can help people leading extremely complicated financial lives and those who have bumpy credit but are getting back on their feet. Just remember, as with many things in life, increased wiggle room is going to cost you, so you’ll want to make sure the loan terms won’t come back to bite you before you jump in.
Auto Loans
When it comes to car loans, think of the maximum LTV ratio as the speed limit: It varies depending on where you go. When you are buying a brand-new ride, you may find that lenders are willing to give you an LTV of more than 100% of the car’s value, especially if you’ve got good credit.
But if you’re looking at a used car or if your credit’s a bit shaky, the lender will pull on the reins and offer a lower LTV, which means you’ll have to put more money down.
Example Loan-to-Value Ratio for a Vehicle Worth $20,000
Down Payment/Trade-In Value | Loan Size | LTV |
---|---|---|
$0 | $20,000 | 100% |
$1,000 | $19,000 | 95% |
$2,500 | $17,500 | 88% |
$5,000 | $15,000 | 75% |
$7,500 | $12,500 | 63% |
$10,000 | $10,000 | 50% |
$12,500 | $7,500 | 38% |
$15,000 | $5,000 | 25% |
$17,500 | $2,500 | 13% |
$20,000 | $0 | 0% |
Where you get your loan from makes a big difference. Loans from regular dealers, banks, or credit unions may have stricter LTV requirements. At the same time, online lenders often allow a little more slack.
Then there are the buy-here-pay-here (BHPH) lots. They’re like the Wild West of auto loans, often not caring too much about LTV. However, you’ll pay for that flexibility with sky-high interest rates.
Examples of Car Loans From Different Lenders
LENDER TYPE | TYPICAL LTV RANGE | DESCRIPTION |
---|---|---|
Banks | 80% to 100% | More conservative, especially with iffy credit. Expect to put down a decent chunk of the car’s value. |
Credit Unions | 90% to 125% | Flexible, especially for members with good credit. It might even let you borrow more than the car’s worth. |
Dealerships | 100% to 130% | Generous with LTV, especially if they want to move cars. They might roll in extras like warranties. |
Online Lenders | 85% to 125% | Competitive, but they’ll check your credit closely. They’ll often offer higher LTVs to attract you. |
Buy-Here-Pay-Here Lots | 120% to 150%+ | Lenient but at a cost. High LTVs come with sky-high interest rates, and the car might not be worth what you’re borrowing. |
Be it new or used, from the bank, credit union, or that seedy car lot down the street, keep your eyes on the LTV ratio. It will help you drive off with the best deal without overpaying.
Refinancing Loans
Refinancing offers you a second chance for financial redemption and is partly dominated by the LTV ratio. When refinancing your home or car loan, for instance, lenders use LTV to determine whether they are willing to give you new terms or lower the interest rate.
A lower LTV is super because it can help you secure better terms. It shows you’ve already paid off a good chunk of the loan, which makes you a safer bet in the lender’s eyes.
There are a couple of reasons people may want to refinance. If refinancing your home, you may be looking to lower your monthly payments, shorten the loan term, or even pull out some of the equity you’ve earned in a cash-out refinancing loan.
Beware: If your LTV is too high when you go to refinance, you won’t get the best deal. In fact, you may not qualify at all.
On the other hand, refinancing the car loan can get you a lower interest rate or stretch out the payments when money is a bit tight.
That’s why being prepared and knowing where you stand beforehand is crucial in refinancing so you can take full advantage of your second shot.
Strategies to Improve Your LTV Ratio
In order to score the best deal on a loan, you may have to ratchet down your LTV ratio. A smaller LTV makes your profile prettier to potential lenders. With some smart moves, you may be able to drop your LTV down and walk away grinning from ear to ear.
Increasing Down Payments
One sure method to reduce your LTV ratio is by making a bigger down payment. The more money you toss onto the table upfront, the less you’ll have to borrow, and that will make you look pretty foxy to the people lending you money.
They are most likely to grant you better terms on a loan when you commit a good chunk of your own money.
Putting down a larger percentage not only reduces how much you’re borrowing but lowers the lender’s risk as well. It’s like showing up to a speed-dating place wearing your best clothing.
When you’ve got more of yourself invested, others feel like you’re more serious about sticking around and acting responsibly.
Improving Property Value
The other way to decrease your LTV ratio is by augmenting the value of your property. Invest in some smart improvements, and the value will go up.
This should help your LTV ratio drop faster than a parachutist with a broken ripcord. By gussying up the kitchen or slapping on a fresh coat of paint, you can influence how lenders evaluate your property’s value.
When the property’s worth more, you don’t have to borrow as much relative to its value. Lenders feel a whole lot better about loaning you the money you want. You don’t have to kill yourself with work to improve your property’s value.
Think of it this way: It may not take all that much to turn a plain old pumpkin into a prize-winning jack-o-lantern at the fair — suddenly, everyone’s more interested.
Paying Down Existing Loans
Finally, reducing the principal of any existing loans can considerably lower your LTV ratio when you are considering refinancing.
The less you owe, the better your LTV ratio looks. That’s a key that can unlock the door to better loan options.
Chipping away at the loan principal is like whittling on a block of wood — give it enough time, and it’ll make a whole world of difference.
As your loan balance shrinks, so does your LTV ratio. You’ll become a prime borrower and have lenders eating out of your hand, just like a hungry mule going after a bucket of oats.
Loan-to-Value Ratio Helps Lenders Assess Risk
The loan-to-value ratio helps lenders make sure they’re not betting the farm on some sketchy deal. By keeping your LTV ratio in check, your chances of getting a loan improve, and lenders will consider you a good bet, not a wild gamble.