You've probably heard the term "loan-to-value ratio" if you've bought a home. Loan-to-value ratio (or "LTV") is a percentage calculated by dividing the amount of the mortgage by the value of the home securing the loan.
Lenders use LTV as a factor to determine what type of loan product a borrower may qualify for. Lenders also use this ratio to help determine what interest rate and other terms to offer. As a result, your LTV can have an impact on whether you get a mortgage and how much you pay for it.
How to calculate loan-to-value ratio
When lenders calculate LTV, they use the appraised value of the home to determine the home's value. The appraised value of a house is not necessarily the same as its purchase price, which is important for homebuyers to understand.
For example, let's say you want to buy a home for $200,000 and make a down payment of $40,000. This means you will need a mortgage for $160,000. Take the mortgage amount and divide it by the sale price to get the loan-to-value ratio. That is …
$160,000 ÷ $200,000 = .08 or 80%
However, let's say the lender obtains an appraisal of the house and that appraisal states the home is worth $190,000. That means the loan-to-value calculation is now $160,000 ÷ $190,000 = 0.84 or 84%.
When you want to refinance your home, the same math applies. Lenders may want an appraisal to determine a house's value or they may accept other estimates of how much it is worth.
Why loan-to-value ratio is important
LTV is important because lenders use it as a measure of a loan's risk. Borrowers with a lower LTV have more equity in their homes and are considered less likely to default. This also means that lenders may view borrowers with a lower LTV as appealing customers and may offer them lower interest rates or better terms to win their business.
Better mortgage choices are not the only way a lower LTV can save you money. LTV can also determine if you need to buy private mortgage insurance (PMI). If you make a down payment of less than 20% on a conventional loan, you will need to pay PMI. This insurance protects lenders when people default on their mortgages. The PMI is added into your monthly mortgage payment.
Ways to buy a house with a less than perfect loan-to-value ratio
If you are dreaming of buying a home but are struggling to pay for it, consider these options. FHA loans are designed to help people with moderate incomes buy houses with lower down payments and more flexible credit score requirements. There are limits on loan size and you will have to pay a mortgage insurance premium however.
Veterans, active duty service personnel, and surviving spouses may be able to buy a home with a VA loan. The benefits of these loans include lower mortgage interest rates and no private mortgage insurance.
Freedom Mortgage is committed to helping Americans achieve the dream of homeownership. Would you like to speak to one of our loan specialists about your options? Then call 877-220-5533 or visit our Get Started page.