Definition of Loan-To-Value Ratio - LTV Ratio
The loan-to-value ratio (LTV ratio) is a lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are generally seen as higher risk and, therefore, if the mortgage is approved, the loan generally costs the borrower more to borrow. Additionally, a loan with a high LTV ratio may require the borrower to purchase mortgage insurance to offset the risk to the lender.
Loan-To-Value Ratio - LTV Ratio Explained
The LTV ratio is calculated as the amount of the mortgage lien divided by the appraised value of the property, expressed as a percentage. For example, a borrower taking on a $92,500 mortgage to purchase a home appraised at $100,000 would have an LTV ratio of 92.50% (92,500/100,000).
The loan-to-value ratio is a critical component of mortgage underwriting, whether it be for the purpose of purchasing a residential property, refinancing a current mortgage into a new loan, or borrowing against accumulated equity within a property.
All lenders assess the LTV ratio in an effort to determine the level of exposed risk they take on when underwriting a mortgage, calculated as the delta between the property's appraised value and the total amount borrowed. When borrowers request a loan for an amount that is at or near the appraised value, and therefore a higher loan-to-value ratio, lenders perceive that there is a greater chance of the loan going into default because there is little to no equity built up within the property. Should foreclosure take place, the lender may find it difficult to sell the home for an amount sufficient to cover the outstanding mortgage balance and make a profit from the transaction.
High LTV Ratio Consequences
While the loan-to-value ratio is not the only determining factor in securing a mortgage or home equity loan or line of credit, the metric does play a substantial role in how much borrowing costs the homeowner. The majority of lenders offer mortgage and home equity applicants the lowest possible interest rate when the loan-to-value ratio is at or below 80%. A higher LTV ratio does not exclude borrowers from being approved for a mortgage, although the total cost of the loan rises as the LTV ratio increases. For instance, a borrower with an LTV ratio of 95% may be approved for a new mortgage, but the interest rate may be up to a full percentage point higher than a borrower with an LTV ratio of 75%. In addition to the higher interest rate, lenders may tack on a mortgage insurance requirement for high LTV ratio transactions. Mortgage insurance has the potential to substantially raise a borrower's monthly mortgage payment, and coverage may be required until the loan-to-value ratio reaches 80%.
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