Loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased, commonly used in real estate transactions by lenders to determine your eligibility for a loan. It is a measure of the amount of debt used to buy a home and compares that amount to the value of the home being purchased. The LTV ratio is calculated by dividing the loan amount by the appraised value of the property. For instance, if someone borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000 to 150,000 or $130,000/$150,000, or 87%. The remaining percentage represents the lenders haircut, adding up to 100% and being covered from the borrowers equity.
Lenders use LTV to determine how much risk they’re potentially taking on if they decide to lend to you and to figure out which loans that you are eligible for based on the size of your down payment or amount of equity that you have in a home. The lower your LTV, the less risky your mortgage will be perceived to be by prospective lenders. Lower LTVs are better in the eyes of lenders, but require borrowers to come up with larger down payments. Most lenders offer mortgage and home-equity applicants the lowest possible interest rate when their LTV ratio is at or below 80%. Mortgages become more expensive for borrowers with higher LTVs.
In summary, LTV is a ratio that measures the amount of debt used to buy a home and compares that amount to the value of the home being purchased. It is an important factor in determining eligibility for securing a mortgage, a home equity loan, or a line of credit, and it can play a substantial role in the interest rate that a borrower is able to secure.
