When we are discussing real estate, LTV (loan-to-value) is a widely used term. But what is LTV in real estate? And how impactful can it be on mortgage loans?
Lenders often employ the LTV ratio to evaluate the potential risks of lending money to you. Regarding mortgage rates for homes, LTV is just one of the many factors considered. Other important factors include your credit score, the lender you choose, and the type of property you're buying.
In this article, we will explore LTV in the context of real estate. Moreover, we will discuss its calculation process, importance, advantages, etc. Keep reading to explore.
What Does LTV Mean In Real Estate?
In real estate, the term LTV (Loan-to-value) is typically used by banks and building associations. This indicates the ratio of the initial mortgage amount to the overall appraised value of the property.
LTV conveys a borrower’s equity against their borrowed home-the amount that would be left after paying off the loan and selling the home. Borrower’s down payment is the inverse of loan-to-value. If the borrower has a 75% LTV, the down payment will be 25%.
It's typical for homeowners to obtain loans with loan-to-value ratios (LTVs) of 80 percent for their primary residences. Normally, lenders require buyers to contribute at least 20 percent of their personal funds toward the transaction.
However, some like to keep their primary fee as small as possible. Besides, commercial properties set their own rules and regulations. In general, having a lower LTV will make you more likely to get a competitive mortgage.
Another related query is, “What is CLTV in real estate?”. Lenders and mortgage professionals calculate combined loan-to-value (CLTV) to determine how much liens burden a homeowner's home.
To calculate the CLTV ratio, you must add the total outstanding loan balances and divide that by the property's current market value.
Why is the LTV ratio important?
Assume that you’re the lender. You would want the extended mortgage loan repaid timely and fussless. High LTVs work as an indicator of the probability of the borrower’s defaulting on the loan.
Such scenarios put the lender in difficulty. If LTV is approximately 90%, the lenders must sell the home for a price that matches it. Otherwise, they might lose their money during a forced foreclosure. That’s not a desirable outcome.
If the LTV is 95%, the lender has no option but to sell the property at a rate very close to the market price. However, if the LTV is 80%, the lender can get an amount below the market value and still regain the acquisition.
And for even lower LTV, the lender might happily escape the transaction without much loss.
How To Calculate LTV for Real Estate?
Calculating LTV is a piece of cake. All you need to do is divide the mortgage amount by any of the appraised worth or the selling cost- whichever is less, and turn the result into a percentage.
Let’s say a home has an appraised value of $400,000. And the mortgage amount is $320,000 against the property. Then the LTV ratio is 80%.
That's good. However, if you were to get a $190,000 mortgage on a property that has a value of $200,000, the following equation would come into action
$190,000/$200,000 =.95 or 95%.
Now that’s not a good one.
How Lenders Use LTV Ratio
When deciding whether to offer you a loan for a home mortgage or help with refinancing, the lender will assess your LTV. This means that you must meet the LTV requirements of the lender, which can vary depending on the lender.
The lender's LTV requirements can affect
- The rates of your interest
- The amount you’ll have to pay as a down payment
- Whether or not you must pay private mortgage insurance (PMI).
It is important to note that your lower LTV will make you appear less risky to the lender.
What is a Good Loan-to-Value Ratio?
Wondering what makes for a great LTV? It all depends on the asset you're financing. For home purchases, an LTV of or below 80% is typically recommended to bypass mortgage insurance fees. With some know-how, you can secure a solid LTV that meets your financial needs.
To attain an LTV of 80%, you simply need to provide a down payment of exactly 20%, along with covering the closing costs. And if you're looking to save even more money, you might consider going for an even lower LTV.
This can make monthly payments low and even qualify you for even sounder interest rates.
How to Interpret the Loan-to-Value Ratio?
Regarding real estate mortgages, the LTV ratio can significantly impact the borrower's credit risk and interest rates. An increased LTV ratio indicates greater credit risk and an elevated interest rate. Conversely, a low LTV ratio implies minor credit risk and a lower interest rate.
Moreover, the LTV ratio determines the demanded down payment, the total quantity of extended credit, and the loan span.
An increased LTV ratio can adversely affect the borrower in many ways. This includes higher interest rates, inflated monthly payments, and the need for PMI. PMI usually has an annual cost of 0.5% to 1% of the entire loan. It must be paid until the LTV ratio decreases to 78%.
The equity of the property might also decrease due to this, leading to a smaller down payment.
Loan-To-Value Ratio Rules By Loan Type
The LTV rules vary based on different types of loans. Let’s look at how the changes occur.
FHA loans are perfect for working-class borrowers, making homeownership more accessible to those who need it most. Federal Housing Administration (FHA) insures and approves a lender for them.
These loans require a lower down payment and credit score than many traditional loans, making them easier to qualify for. You can have a primary LTV ratio of as much as 96.5%.
However, FHA loans do require a mortgage insurance premium (MIP). And, if you choose to refinance once your LTV comes down to 80%, you can eradicate the MIP condition altogether!
VA loans are backed by the government. Veterans and U.S. military personnel are the beneficiaries of these mortgages.
A VA loan can provide 100% financing for eligible borrowers. However, If fees and other expenses at closing exceed the property value, borrowers are generally responsible for the difference.
USDA (U.S. Department of Agriculture) loans help rural individuals get homeownership with as much as 100% financing for existing homes. They wrap up extra expenses for appraisals, taxes, homeowner education, and escrow.
New dwellings have a maximum LTV of 90-100%, but extra costs aren't suitable for financing.
How Does Loan-to-Value Ratio Affect Interest Rates?
It's important to note that U.S. lenders often use pricing based on risks when setting loan interest rates. This means that borrowers who are deemed to be riskier are charged higher interest rates.
This includes borrowers with poor credit scores and high loan-to-value ratios. If your LTV ratio is high, be aware that you may end up with a higher interest rate as you will be marked as risky by the lender.
Loan to Value Ratio Vs Loan to Cost Ratio
Loan (LTC) is another term widely used in commercial real estate. Here’s a table comparing the differences between LTV and LTC
LTV assesses acquisitions and refinances loans.
LTC assesses construction loans.
LTV formula is:
Loan amount/property value
LTC formula is:
Loan amount/ loan cost
How To Lower Your LTV
You can’t just lessen the LTV that easily. It requires a process to be followed, which will require fixedness.
Make A Larger Down Payment
One thing you can do is make the down payment bigger. A larger down payment decreases your LTV because you need less money to borrow. With a mortgage calculator, you can easily see how a larger down payment will impact the monthly payment.
However, it’s not everyone’s piece of cake. Don’t worry, as there are other options.
Look For A More Affordable Home
The best possible option would be to be patient until your savings grow. Afterward, you can buy a more reasonably priced home. Even though the compromise isn't ideal, it can be fruitful in the end - it allows you to make a bigger down payment and possess better equity.
Your rates of interest and lending terms will improve if the LTV is low.
Advantages of a Low LTV for the Buyer
When securing a loan, it's understandable that your main concern is your finances rather than your lender's.
While it may seem tempting to avoid putting down a large sum of money at closing to lower LTV, there are actually several long-term benefits to having a lower LTV. For instance,
- Lower LTV loans often come with lower interest rates. On a 30-year basis, this can add up to significant savings.
- Additionally, if your property's value is already at its maximum, you won’t require refinancing in the future if there is a need.
- Commercial buyers should also consider the advantages of lower mortgage payments, as they can lead to lower operating costs. This means more money for you.
What Are the Disadvantages of Loan-to-Value?
One limitation of using the loan-to-value ratio to assess a homeowner's financial status is that it only considers the initial mortgage, not additional debts.
A more comprehensive measure is the combined loan-to-value (CLTV) ratio. This considers the borrower's outstanding obligations and capacity to refund the home loan.
So, have you got the answer to the question, “ What does LTV stand for in real estate?”. Well, if you read the article, you sure have. Here are some key takeaways from the above discussion
- Lenders prefer lower LTVs, but borrowers must make bigger down payments to achieve them.
- Many lenders will offer the most favorable interest rates if the LTV is 80% or lower when you want a mortgage loan or home equity loan.
- Larger LTVs make mortgages costly on the borrower’s end.
So, you should be concerned about picking a good LTV whenever you are looking for a mortgage loan. In today’s fast-paced world, it’s hard to find trustworthy people. Hence, it’s futile to try to bypass LTV in real estate.
In this case, it’s extremely important to seek professional help in choosing a better LTV that suits both parties. You need to have a proper idea of the scenario.
Excelsior Real Estate can help you here. We bring great expertise to the table regarding arranging a sale, gaining valuable insights on the present market value, or crafting marketing strategies. Rest assured that we will help you make an informed decision about LTV.