LTV Explained: What is “Loan to Value” for a Mortgage?

When going through the lending process, you'll encounter a lot of different terminology that can be confusing – particularly if it's your first time applying for a mortgage. One of these terms is the loan to value (LTV) ratio.

In addition to factors like your credit score, income, and general financial standing, LTV is one of the key factors that can determine the interest rate you're offered on your home loan. It's an important number to understand, and to factor in when you're considering your home purchase.

Why does LTV matter?

LTV ratio measures the market value of your new home (based on an appraisal) against the amount of the loan. It's a ratio that helps lenders calculate the risk they're taking on when they offer you a loan, and the interest rate you're offered can be directly affected by your LTV ratio.

A higher LTV ratio means that you as a buyer are putting down less of your own money and your lender is contributing a larger portion of your overall purchase price. This equates to a larger risk for the lender, which can result in a higher interest rate for the borrower – meaning you're paying more out of pocket over time.

How to calculate loan to value

Loan to value equals loan amount divided by appraised value.

For example, if the home you're purchasing appraises for $300,000 and you make a $30,000 down payment, you'll be looking for a $270,000 loan. 270,000 / 300,000 = .9 or a 90% LTV.

This is most often calculated at the time you're buying your house, but it's also something you'll want to consider if you're thinking about refinancing. LTV changes over time, as you work on paying off your loan and the value of your home changes, so this number will look different as soon as you begin making mortgage payments.

What should your LTV ratio look like?

Ideally, you want your LTV ratio to fall below 80%. If your ratio is higher than 80% (meaning you're borrowing a larger portion of your home's total cost) this is considered more of a risk for the lender, and in addition to the higher interest rates mentioned above, you may be required to get private mortgage insurance (PMI) if you're taking out a conventional loan. PMI is an added level of insurance for the lender in the event that you don't repay your loan.

While PMI can be a necessary expense for those that aren't able to put down a larger down payment, the monthly cost can add up significantly over time. The good news is that when your LTV dips to below 78% as you make regular payments, your lender will remove the PMI as long as your account is in good standing.

How to lower LTV

• Start saving now. 20% can be a significant amount, especially in a competitive housing market. Even if your home purchase seems like it may be far off, start saving now so that you're able to put down a larger down payment when the time comes. You can put down as little as 3% with certain loans, but more savings will equal more options for you!
• Rethink your budget. Consider home options in a lower price range. Your down payment will go further, your LTV will be lower, and your monthly payments will be more manageable.
• After you've purchased your home, there are several ways to keep lowering LTV, which you'll want to do in preparation for a refinance or to work toward removing your PMI. Make mortgage payments regularly to lower the balance on your loan and consider ways to build equity in your home to increase its value. As you know from the calculation we used above, moving these two numbers in opposite directions will have a direct impact on your LTV ratio.

Learn more about Our Team at Acadia Lending Group and how they can help get you a personalized mortgage for your unique situation.