5/5/2023
Buying a home requires you to incorporate a series of calculations that go beyond the price of the property. It is important to know that the average cost of a home reached $405,000 in March of this year, which affects the loan-to-value ratio.
You may be interested in: ITIN mortgage loans
This key metric is used to determine the degree of risk to a lender. If the price of the property is high, the money you are going to give as down payment may not cover the percentage you expect of the price of the property.
This can mean a high LTV, which can affect the interest rate and the final conditions. That is why we will review what the loan-to-value ratio implies and some of its key aspects.
What is the loan-to-value (LTV) ratio?
Simply put, the LTV represents the percentage of the amount you are going to obtain in financing with respect to the value of the home you want to buy. Looked at another way, if your down payment is 10%, then your loan-to-value ratio would be 90%.
This is a key aspect for the lender because the different values related to LTV vary depending on the mortgages available.
It is also important for banks and other financial institutions to assess risk. The less money you put down, the higher the risk and the less favorable the loan terms.
The calculation of this ratio is very simple, you only have to divide the amount of the mortgage loan granted by the appraised value of the property. Let's suppose that the house has a price of $300,000 and you put $30,000 down. In this case we would have:
- $270,000/$300,000 = 0.9 o 90%
What is a good loan to value ratio?
Although an LTV of 90% may be common, some lenders do not want to grant such a high figure. Understandably, lenders will always prefer those who can cover as much of the property they intend to purchase as possible. While a loan-to-value ratio does not mean you will be turned down, ideally it should not exceed a certain limit.
You may be interested in: Bank of America mortgage loans reviews
As a general rule, you should not have a loan-to-value ratio above 80% if you want to secure more favorable contract terms. Of course, you should not be discouraged if for some reason you are not able to meet that 20% down payment.
This is because there are multiple options that can make buying a home possible (USDA, FHA loans, VA, etc.).
What is CLTV (combined loan-to-value ratio)?
This value applies when there is more than one loan associated with a home. For example, a primary mortgage and a second mortgage, such as a HELOC or line of credit. When this happens, you divide the combined balance of the debt you have incurred by the price of the property you wish to purchase.
Lenders take this calculation into account when you apply for refinancing or a home equity loan. Let's say your home has an appraisal of $300,000, you have a $150,000 balance on your first mortgage and you want a $50,000 HELOC. This calculation would look like this:
- $150,000 + $50,000 = $200,000 / $300,000 which gives 0.66 or 66%.
How does the loan-to-value ratio affect your mortgage?
LTV is a critical consideration for lenders when they are evaluating what type of mortgage might work best for you. This value serves to determine your eligibility for mortgage loans that have different thresholds.
Since banks and private lenders typically don't give more than 80%, this calculation is also used to see if you qualify for a HELOC or not.
More than anything else, the LTV is used to define your risk profile against a commitment of this magnitude. As we have explained before, a high loan-to-value ratio implies a higher risk for the lender. In the case of a foreclosure, you may lose more money depending on the amount.
The ways to mitigate this risk is by increasing the interest rate and requiring the purchase of private mortgage insurance (PMI), which is usually taken out to obtain a loan-to-value ratio higher than 80%.
The cost of PMI can depend on your score or level of debt. This policy can add $30 to $70 to your monthly payment for every $100,000 of loan.
You may be interested in: Chase Bank mortgage loans reviews
Ultimately, the loan-to-value ratio is used to calculate the percentage of principal financed out of the total purchase value. Mortgage lenders use the LTV to estimate the level of risk when making a loan. For this reason, the percentage you have will determine the terms and conditions of the contract in case of approval.
When applying for a mortgage, you should not worry if your loan-to-value is too high because there are many government and private programs that allow down payments below 5%. In addition, the bank or lender may approve your request using other criteria, such as your credit history and credit score.
Español: ¿Qué es el ratio loan to value (ltv)?