Loan-to-value (LTV) ratio is a financial term that represents the ratio of a loan amount to the appraised value of the asset or property that the loan is being used to purchase. It is expressed as a percentage and is calculated by dividing the loan amount by the appraised value of the asset or property.
For example, if you are purchasing a house worth $500,000 and taking out a mortgage of $400,000, the loan-to-value ratio would be 80% ($400,000 ÷ $500,000).
LTV is an important factor that lenders use to assess the risk of the loan. The higher the LTV ratio, the riskier the loan is for the lender. Lenders generally prefer lower LTV ratios because it indicates that the borrower has a larger equity stake in the property and is less likely to default on the loan.
Different types of loans have different maximum LTV ratios. For instance, conventional mortgages often have a maximum LTV ratio of 80%, which means borrowers must put down at least 20% of the property's value as a down payment. In contrast, government-backed loans such as FHA loans or VA loans may have higher maximum LTV ratios, allowing borrowers to put down a smaller down payment.
Lenders often require borrowers to purchase private mortgage insurance (PMI) if the LTV ratio exceeds a certain threshold, typically 80%. PMI protects the lender in case the borrower defaults on the loan.
When considering a loan, it's important to understand the loan-to-value ratio and how it affects your borrowing options and costs. A lower LTV ratio generally means better loan terms and lower interest rates, while a higher LTV ratio can result in higher interest rates and additional fees.
