Estimated reading time: 8 minutes
When you’re buying a home, you may hear the term “loan-to-value ratio” during the mortgage process. But what exactly does this term mean, and why does it matter when you’re buying a home?
Your mortgage loan-to-value (LTV) ratio is a percentage lenders use to measure how much of a home’s value you’re borrowing compared to how much money you’re paying up front. This ratio affects your interest rate, your potential down payment, and whether you’ll need mortgage insurance for certain loan programs. While borrowing most of a home’s value can help you save on upfront costs, like your down payment, it may also increase your monthly payments.
Understanding what a LTV ratio is early in the mortgage process can help you budget for costs and make smarter mortgage decisions. Let’s break down what LTV is, how it’s calculated, examples of different percentage ratios, and why it matters for your mortgage options.
Simply, your loan-to-value ratio compares the amount you’re borrowing for your mortgage to the value of the property being purchased. Lenders typically use the lower value of the home’s purchase price or the appraised value when calculating your LTV ratio.
Lenders use this number to measure how risky it would be to give you a loan. The higher your LTV, the more your lender stands to lose if you miss your monthly mortgage payments. A lower LTV shows lenders that you have more funds invested in your home, which may make it easier to qualify for a lower interest rate and help you avoid additional costs, like mortgage insurance.
You can think of your LTV as the opposite of your home equity, which refers to the portion of your property that you own outright. For example, if your LTV ratio is 75%, you are borrowing 75% of your home’s value for your mortgage and have 25% equity.
To calculate your LTV ratio, divide the loan amount by the lower of the home’s purchase price or appraised value. Then, multiply that number by 100 to get the percentage.
The equation for purchases is often written out as: loan amount ÷ purchase price or appraised value × 100.
For refinances, the equation changes to: loan balance ÷ appraised value × 100.
As you pay down your mortgage, your LTV will decrease as your equity increases.
Let’s look at a few examples of LTV percentages. These examples illustrate how different LTV ratios influence borrowing costs, required insurance, and the level of financial risk lenders associate with the loan.
Generally, lower LTV ratios reduce costs and risks. While higher ratios offer more flexibility in your down payment, there are additional considerations.
Home price: $200,000
Down Payment: $20,000
Loan amount: $180,000
LTV: 90%
With a 90% LTV ratio, you are financing most of the home’s value. This means you’ll have less equity up front. Lenders may require mortgage insurance for this LTV to protect themselves in case you default on your loan. Additionally, your interest rate may be slightly higher when compared to a borrower with a lower LTV, which may push up your monthly mortgage payment cost.
Home price: $300,000
Down Payment: $60,000
Loan amount: $240,000
LTV: 80%
An 80% LTV ratio is a relatively strong position for borrowers. You may be able to avoid PMI on a conventional loan, which would save you money on your monthly mortgage payments. Borrowers with lower LTV ratios may qualify for more favorable interest rates.
Home price: $250,000
Down Payment: $12,500
Loan amount: $237,500
LTV: 95%
A 95% LTV ratio is considered high because you’re borrowing nearly the entire price of the home. Lenders will likely require mortgage insurance and may charge a high interest rate to offset the risk associated with issuing you a loan.
High LTV ratios are common for first-time homebuyers who may have limited savings. This can be appealing for homebuyers who don’t have the funds necessary for a large down payment but are comfortable paying more per month until they build more equity.
A high LTV ratio like 95% may be approved, depending on the loan program you choose. Programs like FHA, VA, USDA, and even some conventional loans have different down payment options that don’t require an 80% LTV ratio. These programs are designed to help qualified borrowers purchase a home even if they don’t have a large down payment saved.
Just as mortgage programs have their own benefits and drawbacks, they also have their own standards and requirements for LTV ratios.
Your ideal loan-to-value ratio is dependent on your lender and loan requirements. As a borrower, a “good” LTV ratio means you’re putting down more money for your down payment and borrowing less without stretching your finances.
Much like a DTI ratio, a lower LTV ratio is generally better. A lower LTV generally means you have more equity in your home from the start, while a higher LTV means you will be borrowing more money and putting less down.
Your loan-to-value ratio is just one of the factors a mortgage lender will consider when evaluating your loan application. It impacts your loan approval, how much money your lender may allow you to borrow, and your interest rate. In general, a lower LTV ratio and a larger down payment are just two of the factors that inform your lender that there is less of a risk that you’ll stop making loan payments.
Much like when you first apply for a home loan, your LTV ratio is used during your refinance application as well. Your lender will divide your remaining loan balance by your home’s current appraised value to determine your ratio for the new loan. Just like when you initially borrowed money, LTV will play a role in determining whether you qualify for certain refinancing programs and whether you can remove mortgage insurance.
Your down payment is one of the largest upfront housing costs as a prospective homebuyer and directly influences your loan-to-value ratio. However, if you’re having a difficult time reaching your down payment goals, don’t give up!
Some homebuyers find success by budgeting differently, picking up extra income, or by using gift funds. Additionally, down payment assistance programs are available for eligible borrowers and vary by location and qualification requirements.
By increasing the size of your down payment, you’ll simultaneously lower your LTV ratio and increase your home equity.
Just because you qualify for a certain loan amount, it doesn’t mean you have to borrow that much money. If you find that your budget is stretched too thin for a certain home, you may find more success by broadening your search, including looking for a more affordable property. A lower home price will help reduce your loan amount and lower your LTV ratio. This has the potential to earn you more favorable loan options.
Assisting You Through Your Mortgage Questions
Your loan-to-value ratio is an important part of the mortgage process. It helps lenders evaluate risk and is a key factor in determining your loan options.
By understanding how LTV works and by planning your down payment carefully, you can position yourself for more favorable mortgage terms and long-term financial stability as a homeowner.
To learn more about how certain factors affect your loan options, reach out to us today. Our Loan Originators are ready to guide you through every step of the mortgage process with clarity and confidence.
Homestead Funding offers exceptional customer service and a convenient mortgage process. Whatever your financing needs, our goal is to exceed your expectations.
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