It’s crucial to be well-informed before taking out a mortgage for a house purchase. Defaulting on a mortgage might harm your credit score and result in the repossession of your home. Thus, deciding if you can afford it or recover your losses through a sale is essential.
Loan to value LTV ratio is one of several indicators used by purchasers and lenders to assess the safety of a mortgage. It compares the total loan amount and the property’s appraised value.
In addition to being useful information for you as a house buyer, the LTV ratio is also a metric used by mortgage underwriters to assess the safety of your loan application. Read on to determine a LTV ratio and how it may affect your mortgage application.
What Is LTV?
During the process of approving a mortgage or refinancing an existing one, financial firms and lenders frequently use an indicator known as the loan to value ratio to decide whether or not to proceed with the transaction. Investors can gauge the potential for loss on loan by looking at the LTV ratio. It can also be used as a guide for investors to determine how much equity they have in a certain property.
A high LTV ratio may not rule out a particular investment opportunity, but it may limit your mortgage and financing choices. The reason behind this is because a lender’s confidence in getting paid back is correlated with the value of equity in a house.
A high LTV ratio is the result of a minimal down payment made by an investor or buyer. Potential lenders may become more hesitant to move ahead with the transaction. Keep in mind that LTV is simply one of several criteria taken into account when deciding on a loan option.
Multiple strategies exist for lowering the LTV ratio. The first, and arguably easiest, is to put down a larger upfront cost. Doing this will put you in a position to get a reduced LTV ratio immediately. On the other hand, this may mean putting off a purchase until you’ve saved enough for a larger down payment.
If saving up for a higher upfront payment is out of the question, homebuyers who want to put less than 20% down payment can choose from various low or no down payment programs. Before proceeding with a plan that might not be in your best financial interest, it is best to consider all your options.
How To Calculate Loan To Value Ratio
The loan-to-value ratio can be easily calculated. Simply divide the total loan amount by the property’s most recent appraised value.
Let’s assume you want to purchase a property for $200,000 and put $40,000 down. Your mortgage loan amount is the remaining $160,000. To compute the LTV ratio, you must divide the $160,000 by $200,000. That comes out to an LTV of 80%.
To put it simply, below is the mathematical formula of the calculation:
Loan Amount / Appraised Value of the Property = LTV ratio
How LTV Affects Your Mortgage Loan Options
Various mortgages have different standards and restrictions on loan to value ratio. Therefore your LTV will play a factor in selecting which mortgage you will get. The following are some of your possible options.
Mortgages that a government agency does not guarantee are referred to as conventional loans. A debt-to-income (DTI) ratio of no more than 50% is required for these loans. Moreover, applicants must also have a credit score of 620 or above.
LTVs as high as 97% are possible with conventional loans, and down payments as little as 3% are usually accepted. However, you will need PMI coverage which comes at a cost.
The Federal Housing Administration (FHA) insures a certain type of mortgage loan. To be eligible, they need a credit score of 580 or greater.
With an FHA loan, the minimum down payment is only 3.5%, making it a perfect option for borrowers with an LTV of 96.5 or lower. Because of your lower down payment, you will be obliged to pay mortgage insurance until you reach 20% equity. At that point, you may refinance into a conventional loan and cancel the policy.
Federal Housing Administration loans are good for first-time purchasers and people with less-than-perfect credit because of the lenient eligibility requirements and lower down payments.
VA loans are guaranteed by the Department of Veterans Affairs and are exclusive to qualifying veterans, active-duty military members, and their surviving spouses.
VA loans simplify the home-buying and refinancing processes compared to conventional mortgages. A Loan to Value LTV ratio of 100% is offered for VA loans, allowing eligible borrowers to finance the full purchase price of a property with no upfront payment or closing costs.
What Is Considered A Good Loan To Value Ratio?
A higher LTV indicates a greater debt on the property, and a lower LTV indicates a greater equity position. High LTV ratios aren’t always a deal breaker when applying for a mortgage. However, a higher-than-usual interest rate might be a possibility for you. Lenders use loan to value ratio to determine whether or not to grant or refinance a loan. While there is no universally accepted ratio, there are boundaries and ranges that lenders work within.
LTV ratio examples vary widely depending on the financing you’re considering. When estimating your loan to value ratio, be sure to take into account the specific criteria for the financing you’re seeking. Consider the following examples:
LTV For Conventional Loans
There should be no more than an 80% LTV ratio for you to proceed with a conventional mortgage. Or, your lender may require that you get private mortgage insurance and include the amount in your monthly repayments. To obtain this LTV, you must make a minimum 20% down payment.
LTV For FHA Loans
Federal Housing Administration mortgages also factor in LTV. For FHA loans, the maximum LTV ratio is based on your credit score. For instance, a loan to value ratio of 96.5 percent may be possible with FHA loans if the borrower has a credit score of 580 or above. The highest LTV ratio approved for consumers with credit scores between 500 and 579 is 90%.
LTV For VA Loans
Veterans can apply for VA loans, which are guaranteed by the federal government and offered to qualified individuals. These will allow for a loan to value ratio of up to 100%, which means you may buy a home with a little or even zero down payment. To be eligible, however, one must also satisfy certain conditions.
LTV For USDA Loans
USDA loans, which are government-insured mortgages, are another alternative that requires no upfront payment and permits a loan to value ratio of 100 percent. Again, there are standards for qualification, and these programs tend to favor residents in rural areas.
Private Mortgage Insurance And LTV
Most financial institutions will require private mortgage insurance if the loan to value ratio exceeds 80%. As a result, it might increase your yearly mortgage payment by 0.5% to 1%.
PMI, if necessary, can be paid in a single lump payment at closing or factored into the mortgage. If you’ve been making your mortgage payments on time and the LTV ratio goes below 80%, you’ll no longer be required to pay for private mortgage insurance.
Getting A Loan With High LTV
Your loan to value LTV ratio will affect your mortgage rate most among all secured loans. Any loan program’s interest rate may increase if the LTV is beyond a certain limit. It is because there is more risk for the lender in this deal.
Thus, bringing the LTV ratio down as much as possible is a good idea. However, there are cases where it makes sense to get a mortgage despite having a high LTV. The following are discussions of a few of these possible scenarios.
The New Mortgage Will Save You Money
Buying a property before saving enough for a large down payment may be worthwhile if the cost of renting is higher than the monthly mortgage payment. Mortgages can be a good option, but you should weigh all of the fees involved carefully before making a final choice.
If you cannot put down a sizable amount, you should prioritize being able to pay your mortgage, property taxes, and insurance.
Traditional mortgage lenders require as little as a 3% down payment, and many more provide no-down payment options. If qualified, keep in mind that 100% financing is available with VA and USDA loans.
You Need An Emergency Fund
The interest rate on loan might be lowered if a large down payment is made. However, using your money might leave you in an unstable financial position.
Many people think of the LTV as a hard and fast rule beyond which you should never go. Others think that mortgage insurance is a complete and utter waste of money.
However, this is only a portion of the whole narrative. You also have to prioritize setting up a sufficient emergency fund. If you run into unexpected financial difficulties, you will not be able to get your down payment or any other money you put toward a property back from the lender.
Think about what you’re willing to set down and what you’d rather put aside in case of an emergency. It’s possible that the extra cost of your monthly payments will be justified by the sense of security it provides.
You Can Obtain Greater Value For Your Money Elsewhere
To maximize the return on a low-interest loan, consider investing a portion of the upfront payment you plan to make.
Keep in mind, however, that even if investing instead of pursuing a lower LTV makes more sense, it may not be a good strategy if you are normally debt conscious. Even though there is a chance that you may make more money trading on the market than you would save in interest, the additional stress may not be worth it.
How To Improve Your LTV Ratio On A New Home
Below are strategies to lower your loan to value ratio, whether purchasing a new house or refinancing.
Make A Larger Down Payment
Putting down more money on a house purchase reduces the loan to value ratio. Your down payment reveals the risk associated with your loan for lenders and mortgage investors. Lenders will have a better impression of a buyer as a responsible borrower if they perceive that they are willing to put down a larger down payment.
Pick A Less Expensive House
You can also consider looking at more affordable properties if you are on a tight budget and unable to make a higher down payment. Your LTV will decrease, which might help you qualify for a better loan.
LTV may be improved by changing two variables: the loan amount or the property’s appraised value. Decrease your LTV ratio by looking for a house with a lower appraisal value.
Make Some Extra Payments
Once your loan is active, you can lower your LTV by making prepayments or extra repayment. You may do this in several ways, including increasing your monthly pay or applying bonuses or tax returns to the principal.
The Bottom Line
Remember, your LTV is simply one aspect of your mortgage application. The lower your loan to value ratio, the more probable it is that your interest rates and mortgage insurance premiums will be reduced.
As such, homeowners and investors need to learn about the criteria used and the minimum loan to value ratio that may be required. There are a wide variety of criteria that must be met to qualify for any given form of financing. Thus, it is best to seek the advice of real estate experts if you are overwhelmed by the complexity of this circumstance.
We at Homes By Ardor are dedicated to educating our clients and assisting them in making the most informed decision regarding real estate. Please get in touch if you have any questions or issues about LTV that you can’t seem to figure out on your own.