Basically, your loan-to-value (LTV) ratio is the flip side of your down payment, assuming that the purchase price equals the appraised value of the home. So if you are putting down 20%, your LTV is 80%. If there is a difference between the appraised value and the price you agreed to pay, the lender will use the lower number to calculate your LTV (loan amount divided by appraised value or purchase price). This is true whether you are buying or refinancing. With an LTV of 80% or lower, you are eligible for lower mortgage/refi rates and more favorable terms. You can take several steps to lower your LTV, including working with a financial advisor to boost your savings and make a larger down payment.
How to Calculate LTV
The loan-to-value (LTV) ratio is the percentage of your home’s appraised value (or purchase price if it is lower) that you are borrowing. To calculate your LTV ratio, take your mortgage amount and divide it by the purchase price or appraised value of the home, whichever is lower. Then multiply by 100 to turn the ratio into a percentage.
Say you’re buying a $300,000 home and taking out a $250,000 loan. To calculate your LTV, divide 250,000 by 300,000; then multiply the result by 100. The result: your LTV is 83.3%. When you subtract the LTV from 100%, you typically get your down payment expressed as a percentage.
Why LTV Is Important
The higher your LTV ratio, the higher the mortgage rate you’ll be offered. Why? With a higher LTV, the loan represents more of the value of the home and is a bigger risk to the lender. After all, should you default on the loan and your home goes into foreclosure, the lender will need the house to sell for more to get its money back. Put another way, in a foreclosure, your down payment is the “haircut” the lender can take on the sale price of your house. So the smaller the haircut (or your down payment), the less likely the lender will get all of its money back.
Additionally, when your LTV is high and your down payment is relatively small, you have less to lose if you default and walk away from the loan (and home). In other words, you’re more likely to stick around if you put down 20% down than a 3%.
What Exactly Is a Good Loan-to-Value Ratio?
What’s considered a good LTV ratio varies depending on the type of loan you’re applying for.
Conventional Mortgage LTV
If you’re applying for a conventional mortgage loan, a decent LTV ratio is 80%. That’s because many lenders expect borrowers to pay at least 20% of their home’s value upfront as a down payment.
FHA Loan LTV
Mortgage loans backed by the Federal Housing Authority (FHA) come with a different set of rules. For homebuyers who are trying to qualify for an FHA loan, an acceptable loan-to-value ratio is 96.5% if your credit score is at least 580. If your credit score falls between 500 and 579, your LTV ratio can’t be higher than 90%.
For example, if you’re buying a home that’s appraised at $200,000, your loan can’t be more than $180,000. That means a minimum $20,000 down payment so that you stay at 90% LTV ratio.
USDA Loans and VA Loans
If you’re applying for a loan that does not require a down payment such as a USDA loan or VA loan, your LTV ratio can be as high as 100%. Of course, you’ll need to meet other qualifications in order to be eligible for these kinds of mortgages, such as income requirements and property location rules or specific military status.
Refinancing a Loan
Borrowers who are refinancing may or may not need a specific LTV ratio. For example, if you’re refinancing through the federal Home Affordable Refinance Program (HARP), your LTV ratio must be higher than 80%. But if you’re interested in an FHA streamline refinance, there are no LTV ratio limits.
What If Your Loan-to-Value Ratio Is Too High?
Having a high LTV ratio can affect a homebuyer in a couple of different ways. For one thing, if your LTV ratio is higher than 80% and you’re trying to get approved for a conventional mortgage, you’ll have to pay private mortgage insurance (PMI). Fortunately, you’ll eventually be able to get rid of your PMI as you pay down your mortgage. Your lender must terminate it automatically when your LTV ratio drops to 78% or you reach the halfway point in your amortization schedule.
If your LTV ratio is too high, taking out a mortgage loan will also be more expensive. By making a small down payment, you’ll need a bigger loan. In addition to paying PMI, you’ll probably pay more interest.
A high LTV ratio can prevent a homeowner for qualifying for a refinance loan. Unless you can qualify for a special program (like HARP or the FHA Streamline refinance program), you’ll likely need to work on building equity in your home.
The loan-to-value ratio is just one factor that mortgage lenders consider when deciding whether to approve a borrower for a mortgage or a refinance loan. There are other factors that lenders take into account, such as credit scores. But if you want a low mortgage rate (and you want to avoid paying PMI), it’s best to make a sizable down payment and aim for a low loan-to-value ratio.
Tips on Securing a Favorable Mortgage Rate
- If you can’t make a reasonable down payment now, don’t rush into the home buying game. Take some time to build up your funds so you can get a lower interest rate on your loan. Check out our reports on the best savings accounts and best certificate of deposit (CD) rates around.
- For help with budgeting and saving, consider working with a financial advisor. A financial advisor can help you define your goals—and reach them. SmartAsset’s financial advisor matching tool makes it easier to find an advisor who suits your needs. Simply answer a few of questions about your financial situation and preferences, and the program will connect you with up to three financial advisors in your area.
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