Definition: Loan-to-Value (LTV) ratio is a financial term used by lenders to assess the risk of a mortgage loan. It represents the percentage of a home’s purchase price or appraised value that is financed through a loan. The higher the LTV ratio, the greater the perceived risk to the lender.
Explanation: Lenders calculate LTV by dividing the loan amount by the property’s value. The LTV ratio is crucial because it determines mortgage approval, interest rates, and whether private mortgage insurance (PMI) is required. Generally, the lower the LTV, the better the loan terms. Conventional lenders often require an LTV of 80% or lower to avoid PMI, meaning the borrower must provide at least a 20% down payment.
For government-backed loans like FHA loans, buyers may qualify with an LTV as high as 96.5%, meaning they only need a 3.5% down payment. However, higher LTV ratios increase lender risk, which often results in higher interest rates or additional fees.
Example: A buyer purchases a $400,000 home with a $320,000 loan and a $80,000 down payment. The LTV is calculated as follows:
LTV = ( 320,000 ÷ 400,000 ) × 100
LTV = 80%
Since the LTV is 80%, the buyer avoids PMI. However, if they had only put $20,000 down (5%), their LTV would be 95%, requiring mortgage insurance until they build more equity.