Loan To Value Ratio

The loan to value ratio is one ratio important to both the lender and the borrower. The lender uses it as an index to determine the risk factor involved and the borrower uses it to determine whether one can qualify for a loan and to what extent.

The factor is a simple ratio between the loan amount and the purchase price or the appraised value (whichever is less) of the property you intend to pledge expressed as a percentage.

For example, if the loan you intend to take is $375,000 then the loan-to-value ratio becomes 75% (say) for a property whose value is $500,000.

Simple mathematical calculation:
Total loan balance = 1st mortgage + 2nd mortgage (if any) + 3rd mortgage (if any)
Market value of the property = Purchase price or appraised value (the lesser of the two)

What does LTV determine?

• The amount of equity in your property: The actual equity is the value of the property without the liens. Let us take the above example, 75% LTV means, the house equity is 25%.



• The amount of down payment you are expected to make.



• The fees you will be charged. The origination and documentation charges increase with the increase in the ratio. These costs amount to one percent of the loan value.



• The PMI you have to pay (if at all): If your LTV is more than 80% then you have to pay the mortgage insurance premium rolled in with your monthly payment.



• The impound or escrow amount you might have to pay.

Why is LTV so important?

• The more the LTV the more risk you are to the lender. If you make a reduced down payment, you still have a huge loan balance left. Thus the risk of a default is always there. Lenders do not prefer high LTV ratios.



• A high LTV means higher mortgage costs because of the PMI added, also the interest rates will be higher and it will be difficult for you to qualify for all kinds of loans.

Purchase price Vs Appraised value
There is also an ongoing dispute as to which price is to be taken as the Fair Market Value of the property, the purchase price or the appraised value of the property.
The purchase price is the cost arrived at when the property is to be bought from a seller and the mortgage is to finance the same.

The lender prefers the purchase price because he feels the price is a negotiated deal and it is to his likeness. On the other hand the mortgage broker prefers the appraised value because it is he who has engaged the professional appraiser for the purpose. The final decision is taken by the lender anyways; he chooses the lesser of the two.
Other factors:

• LTV cut-off: Not all mortgages allow same LTV ratios. Always check on the LTV cut offs during shopping for loans.


• 110-125% LTV: In competitive markets some lenders offer 110-125% LTV. Beware of these as they come with unaffordable rates as well.