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Understanding LTV: What Is A Loan-To-Value Ratio And How Can It Affect You?

Molly Grace5-Minute Read
December 03, 2021

If you’re new to the world of credit and borrowing, the alphabet soup of terms used by lenders can be a lot to swallow; DTI, PITI, ARM, PMI, FHA, LTV … the list of acronyms and initialisms is as long as it is confusing.

LTV is an important one to know if you plan on taking out a secured loan – and fortunately, it’s a pretty simple concept to understand. It all has to do with the size of your loan relative to the cost of the thing you’re using it to purchase.

What Is LTV?

Loan-to-value (often abbreviated as “LTV”) is a ratio that shows the loan amount compared to the value of the asset purchased with that loan, often a home or vehicle. Lenders will look at the LTV of a proposed loan when determining certain aspects of a loan – such as its interest rate – and whether or not it can ultimately be approved.

In this article, we’re going to focus mostly on LTV as it relates to home loans, or mortgages.

When you get a secured loan like a mortgage, you’ll typically need to put some money down to get the loan. LTV is the inverse of your down payment. If you put down 20%, your LTV would be 80%. If you make no down payment and use a loan to cover the full cost of your purchase, your LTV would be 100%.

LTV helps the lender assess how much risk they’re taking on when they lend money to a borrower. They’ll look at other factors, too – like the borrower’s credit history and debt-to-income ratio – but LTV ultimately tells them how much they’ll be on the hook for if the borrower defaults on the loan.

The higher your LTV, the more risk the lender takes on, and the more you’ll likely pay to borrow money.

How Is LTV Ratio Calculated?

To calculate a loan’s LTV, follow this formula:

Your loan amount is the total amount you’ll be borrowing. If you’re purchasing a home that’s listed for $200,000 and making a $40,000 down payment, your loan amount would be $160,000. To find your LTV, you’d divide 160,000 by 200,000 and get 0.8. Multiplied by 100, your LTV ratio would be 80%.

When you purchase a home, your LTV will be based on either the purchase price or the appraised value, whichever is lower. If you refinance your mortgage, your LTV will always be based on your home’s appraised value.

What Is A Good Loan-To-Value Ratio?

An LTV of 80% is often thought of as the “ideal” mortgage LTV, because this is the threshold at which you won’t need to pay mortgage insurance. If you make a down payment that’s less than 20%, thus making your LTV higher than 80%, you’ll pay a mortgage insurance premium as part of your monthly mortgage payment. Lenders like lower LTVs because it lowers the risk they take in making the loan.

Why does a lower LTV = lower risk for the lender? When a mortgage borrower defaults on their loan, the foreclosure process allows the lender to sell the home to try to recoup their losses. The less of their own money they have tied up in the home, the more likely they are to get paid back the full amount. Additionally, the more money you, the homeowner, have tied up in your home, the less likely you are to default or walk away.

But 80% isn’t the cut off for the maximum LTV borrowers can have for most loans, and it’s not even necessarily the ideal LTV for every borrower. FHA loans allow LTVs up to 96.5%, while some conventional loans allow borrowers to go as high as 97% (meaning you’d make a 3% down payment). If you qualify for a VA loan or a USDA loan, it’s possible to have an LTV of 100%, meaning the full cost of the home is financed and you don’t have to make any down payment at all.

Your maximum allowed LTV may also depend on whether you’re purchasing or refinancing, and if you’re refinancing, which type of refinance you’re doing. For rate and term refinances, LTV requirements are typically similar to those for purchase transactions. If you’re getting a cash-out refinance, however, you typically will need to keep at least 20% equity in your home (which equals an LTV of 80%) unless you’re getting a VA cash-out refinance, which allows LTVs up to 100%.

Ultimately, the right LTV for you balances the amount you’re able to put down with your desired monthly payment and your lender’s limits on how high of an LTV they’ll allow. While a larger down payment means a lower LTV and likely a more affordable monthly payment – due to having a lower interest rate and having to borrow less money overall – it’s not always feasible for borrowers to put a lot of money down. As you consider how much you can afford to put down on your home, it’s important to think about both your upfront costs and the long-term cost of having a higher LTV.

How To Lower Your LTV Ratio

One obvious way to lower your LTV is to make a larger down payment. If your savings are limited but you’re set on keeping your LTV at 80% or lower to avoid mortgage insurance and get access to better rates, you might consider pushing back your home purchase timeline to save more for your down payment. You can also reduce your home buying budget so that your down payment will account for a larger percentage of the total value of the home you purchase.

Over the long term, paying down your mortgage balance and increasing the value of your home will increase the amount of equity you have and reduce the value that’s tied up in a loan. Homes typically gain value through appreciation over time, but homeowners can also make improvements to increase value. By paying down your mortgage or increasing your home’s value, you can lower your LTV. If you have a conventional loan with mortgage insurance, you can even have your mortgage insurance premium removed from your monthly payment once you reach an LTV of 80%.

The Bottom Line

Keeping your LTV as low as possible can help you get better rates and a lower monthly payment, but that’s often easier said than done. As you begin the process of shopping for a mortgage or other type of secured loan, such as an auto loan, take some time to consider what you can afford to pay both upfront and on a monthly basis. Though having a low LTV means making a larger down payment, it can ultimately help you save a lot of money in interest costs throughout the life of the loan.

Keep reading the Rocket HQSM Financial Learning Center for more tips to help you on your home buying journey.

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Molly Grace

Molly Grace is a staff writer focusing on mortgages, personal finance and homeownership. She has a B.A. in journalism from Indiana University. You can follow her on Twitter @themollygrace.