Loan-to-value ratio (LTV ratio) measures the value of an asset compared to its financed amount. Most of the time, you will see loan-to-value ratios with secured loans, more specifically mortgage loans, home equity loans, or home equity lines of credit. Another way to see a loan-to-value ratio is how much money you owe on a home when it is financed.
Knowing a home’s loan-to-value ratio can be helpful when applying for a mortgage or a home equity loan/line of credit, as it will significantly impact these loans. Below is a step-by-step guide on calculating your loan-to-value ratio.
The Steps for Calculating a Loan-to-Value (LTV) Ratio
Here is how you can calculate your loan-to-value ratio:
Step One: Get Your Appraised Value and an Accurate Loan Amount
You need to have your home’s appraised value and the most up-to-date loan amount to get started.
Step Two: Learn the Formula
The formula for calculating your loan-to-value ratio is:
The current loan balance is divided by the current appraised value to get the LTV ratio. You will need to convert the final number into a percentage (which can be done by multiplying by 100).
Step Three: Plug in Your Numbers
The next step is to plug in the numbers. For example, let’s say your home value is $250,000 and your loan balance is $100,000. Here is how you would calculate your loan-to-value ratio:
100,000 / 250,000 = .4
.4 x 100 = 40
And so, in this case, your loan-to-value (LTV) ratio is 40%.
Calculating a Combined Loan-to-Value (CLTV) Ratio
A combined loan-to-value ratio is used when taking out a home equity loan or home equity line of credit. Essentially you are combining the new loan amount from the home equity loan or line of credit with your existing mortgage balance. You can add any existing home equity loans if applicable. Here is how to calculate your CLTV ratio:
Step 1: Have the Necessary Information
You will need to know your current mortgage loan balance—most lenders/financial institutions will have that information on your statement balance. You will also need to know your assessed property value and the loan amount you are looking to borrow from your home equity loan or line of credit.
Step 2: The Formula for Combined Loan-to-Value Ratio
The combined loan-to-value ratio formula is almost identical to the formula above. You will just need to add the new loan into the right spot—adding it to the existing loan amount.
To calculate CLTV ratio, you will have to add your home equity line of credit or loan amount to the existing loan balance and then divide that by your home’s assessed value. And then, just like the formula from above, you will have to multiply the number you get by 100 for the percentage.
Step 3: Plug in Your Numbers
As an example let’s say you want to take out a $10,000 loan on your home, which is worth $250,000 and your outstanding mortgage balance is $100,000. Here is how you would plug in the numbers:
(100,000 + 10,000) / 250,000
110,00 / 250,000 = .44
.44 x 100 = 44
So, in this case, your combined loan-to-value ratio is 44%.
How Loan-to-Value Ratio Impacts Mortgages and Home Equity Loans
A home’s loan-to-value ratio will play an important role in both your mortgage process and when applying for home equity loans and lines of credit.
Impact on a Mortgage
Mortgages are very different from something like personal loans. Lenders will have many things to look at including the home’s loan-to-value ratio. When it comes to mortgage refinancing or approval, they will pay close attention to this value to figure out the mortgage amount they feel comfortable with giving out. They will want to make sure that if you cannot pay back the loan, they will be able to get their money back from the home. One reason why having an appraised property is essential for the home buying process.
Generally speaking, the higher the LTV ratio, the higher the risk there is for the lender, while the lower the LTV, the lower the risk. With more risk comes additional costs for the borrower and more requirements for approval.
For example, with a higher LTV ratio, you may be required to pay private mortgage insurance each month, have a larger down payment on the home, see a higher interest rate, and have higher monthly payments.
Another thing to keep in mind is that when buying a home, the home’s LTV and the lender’s mortgage program will determine the mortgage amount you will be able to borrow.
For example, some lenders may only allow a maximum LTV ratio of 96%. If that is the case, you will need to figure out the down payment amount to move forward with the mortgage process.
Keep in mind that one lender, financial institution, and mortgage type may be more flexible than another. For example, Federal Home Loan Banks (regulated by the Federal Housing Finance Agency) may offer more flexibility than a bank or credit union. Or, if you are a first-time home buyer or veteran, you can look into FHA loans or veteran home loans, which are less expensive and more flexible than conventional mortgages.
Impact on a Home Equity Loan or Line of Credit
With a home equity loan, a higher combined loan-to-value ratio will make it harder for you to get funding. Just like a mortgage loan, which is secured from your home’s value, eligibility for a home equity loan or line of credit will also depend on that. If you cannot repay the borrowed funds, lenders will want to make sure they can get their funds back through the home.
The lower your combined loan-to-value ratio, the more lenders you will have access to, and the higher loan amounts you could get.
Reducing Your Loan-to-Value Ratio
You can definitely reduce your loan-to-value ratio on a home you currently own or are trying to purchase. Here are some strategies you can use:
Increasing Your Down Payment on the House Purchase
For most mortgages, you will need a minimum of 3% of a down payment on a home, which does not include all closing costs. Adding more to that payment can help lower your loan-to-value ratio. Many people ask for gifts from their families during this time. If you don’t have that option, then consider a loan option such as a personal loan, which are installment loans also available for bad credit borrowers. Or you can consider stopping the home search altogether and waiting until you save more money. A larger down payment will also mean lower mortgage payments, which can be a huge plus!
Make Increased Monthly Payments on Your Loan Principal
One easy way to lower your loan-to-value ratio is to make increased payments on your mortgage every month. The more money you pay, the more it will go towards the principal, and the sooner you will pay off your loan.
Look at a 15 Year Mortgage Rather Than a 30
When looking at mortgage options, you will see a few loan repayment options. The standard is 30, but you can go as little as 15 years on your mortgage. With a 15-year repayment option, you will have larger payments each month, but you will also repay your loan much quicker, lowering that loan-to-value ratio sooner.
Lower Your Price Range for a Home Purchase
Mortgage companies will provide you with a home loan estimate after the pre-approval process. However, just because you qualify for a large mortgage, you don’t have to go for that maximum amount, especially if you don’t have a significant down payment.
And so, definitely consider a lower purchase price for a home, even if it doesn’t mean getting everything you want from your home purchase right away. Having a lower monthly payment will help alleviate the burden of that monthly mortgage payment and free up money for other things. You can use that extra money to turn your home into your dream home over time rather than paying for it all right away.
Key Takeaway With Calculating Your Loan-to-Value Ratio: It Impacts Mortgages and Home Equity Loans
You can calculate your loan-to-value ratio by dividing your loan balance by your home’s assessed value. A combined loan-to-value ratio occurs when you combine a second or multiple loans (which use your home as collateral) into your existing loan balance. To calculate this, all you need to do is add the new loan(s) to the current balance and then divide it by the home’s value.
Your loan-to-value ratio will play a massive role in the mortgage process, from approval to the monthly payment minimum. With home equity loans, it will also determine approval and the lenders you can work with.
References:
What Is a Loan-to-Value Ratio? | FHA
What is a loan-to-value ratio and how does it relate to my costs? | Consumer Financial Protection Bureau
