Loan-to-Value Ratio: Why Does It Matter?
Even though you may be a homeowner, your mortgage prevents you from having complete ownership of the home. A down payment is the initial, out-of-pocket expense associated with a major purchase; the remaining funds are utilized to pay for the property using a loan.
With each mortgage payment, the percentage of the home you actually own rises. Loan-to-value (LTV) ratios are utilized by creditors as a proxy for gauging the percentage of equity debtors have in their properties.
When applying for a refinance, considering your loan-to-value (LTV) ratio is essential. If you are aware of your credit score, you will be able to use it to evaluate whether or not you are eligible for a refinance, how much equity you have ready to draw, and whether or not you will be obligated to incur private mortgage insurance (PMI) on your subsequent loan.
What Is the Loan-to-Value or LTV Ratio?
The loan-to-value (LTV) ratio is a figure that reflects the connection between the amount of money still owed on a mortgage (the loan) and the worth (the value) of the home. This number is represented as a percentage.
Having an understanding of your loan-to-value (LTV) ratio will help you get a better grasp on the proportion of your home’s value that is actually in your possession. Your equity can be calculated by deducting your LTV percentage from 100. For instance, if your loan-to-value ratio is 75%, you only have equity in your home amounting to 25%.
Your LTV ratio should be as low as possible. Homeowners with a lower ratio have greater equity in their properties and are getting closer to full ownership.
If your loan-to-value (LTV) ratio is low, your refinancing application will have a better chance of being granted. It is possible to negotiate more favorable terms on a mortgage refinance if your loan-to-value ratio has improved.
What Is a Good LTV ratio?
Conventional thinking claims that a loan-to-value ratio of 80% or less is preferable for a house loan in order to avoid private mortgage insurance premiums. Putting down a 20% or more deposit at the time of purchase is common practice in this context.
The potential for a reduced interest rate on the mortgage could save the debtor thousands of dollars over the course of the loan. In addition to the cost savings already possible, avoiding PMI might allow for even greater cost reductions.
On the other hand, auto loans typically have a higher LTV ratio than other types of loans since people choose to borrow larger amounts to finance their vehicles. Due to the rapid depreciation in value that automobiles are subject to compared to other asset classes, it is possible to borrow at an LTV of more than 100%.
When you get a home equity loan, you are borrowing against the equity in your property, which raises your LTV ratio. Assuming you can get an appraisal to back up the increase in value, rising housing prices will reduce your LTV. If you need a loan to construct a new house, you may be able to utilize the value of the land itself as collateral.
How to Calculate LTV?
The LTV ratio is calculated by dividing the mortgage debt by the home’s market value and then multiplying the result by 100.
Suppose an appraiser visits your home and gives you a report saying it’s currently worth $300,000. Although you have previously made some payments toward your mortgage, you still have a balance due of $250,000.
Divide $250,000 by $300,000, and you’ll get 0.833. Multiply that by 100 to get 83.3. You have an LTV of 83.3% and an equity level of 16.7%.
How Do Lenders Determine LTV?
Your creditor will look at your LTV before assessing whether or not to give you a mortgage loan or help you with a refinance.
As a result, your interest rate, down payment amount, and PMI premiums can all be affected by the LTV requirements of your creditor. This will vary from creditor to creditor. To clarify, the creditor perceives a lower level of risk when the loan-to-value ratio (LTV) of the debtor is lower.
What Effect Does LTV Have on Interest Rates?
To improve your chances of getting a mortgage loan approval, you should prepare a strategy for making a down payment equal to at least 20% of your home’s worth. This would result in a loan-to-value ratio (LTV) of 80% or less.
If your loan-to-value ratio is higher than 80%, it is possible that your loan application will be denied, or you may be compelled to acquire mortgage insurance in order to have your loan approved.
LTV is also significant since a bigger down payment may be compelled to stay within the LTV limits set by your creditor if the appraised worth of the property turns out to be significantly lower than the acquisition price.
If you currently own a house and are considering obtaining a home equity line of credit (HELOC), most creditors will allow you to borrow up to 90% of your home’s worth when paired with your existing mortgage.
If the value of your property has decreased from the time that you acquired it, it is possible that you will not even be able to qualify for a home equity loan or a home equity line of credit (HELOC).
Is Having a High LTV Good or Bad?
A homebuyer’s situation can be altered in a few distinct ways if the LTV ratio of the home is high. One thing to keep in mind is that you will be compelled to pay for private mortgage insurance (PMI) if your loan-to-value (LTV) ratio is greater than 80% and you are attempting to get approved for a traditional mortgage.
As you make progress toward paying off your mortgage, you will, fortunately, reach a point where you will no longer require private mortgage insurance. When your loan-to-value (LTV) ratio falls to 78% or when you reach the 50% mark in your amortization schedule, your creditor is obligated to instantly terminate it.
If your loan-to-value ratio (LTV ratio) is too high, getting a mortgage loan would also cost you more money. You will be compelled to take out a larger loan if you choose to make a lower down payment. You will most likely incur extra interest payments in addition to the PMI premiums.
A homeowner may not be able to qualify for a refinance loan if their LTV ratio is too high. Unless you are able to demonstrate that you meet the requirements for a specific program, you should focus on increasing the equity in your house.
How to Lower Your LTV
Your LTV ratio can be lowered in one of two major ways: either by paying down your mortgage or by increasing the equity of your home. Here are several approaches to accomplish both of these goals.
- Be patient – You should wait to refinance until you have paid down some of your mortgages if you’re not in a major hurry. Calculate your current LTV ratio and the time compelled to reduce it to below 80%.
However, even if you aren’t quite there yet, waiting a year or two to refinance could help your equity develop to a point where you can get better rates.
If you believe the value of your house will rise, waiting may also be beneficial. Maybe things have been looking up in your area recently, or maybe home prices have risen. As the market value of your house rises, your LTV ratio would naturally improve.
Waiting, however, could prove counterproductive if you anticipate a decline in your home’s value during the next few months.
- Pay extra mortgage installments – Is it possible to make a prepayment on your mortgage, or a small extra payment, before you refinance? If you make extra payments on your mortgage, your principal balance will eventually drop.
Find out whether there are any prepayment fees from your creditor before you make any extra payments. In most cases, creditors will not charge you a fee for prepaying a loan early, but they may do so if you prepay a large sum.
Final Thoughts
When assessing whether or not to grant a debtor a mortgage or a loan to refinance an existing loan, mortgage creditors take into consideration a number of criteria, one of which is the loan-to-value ratio.
Moreover, creditors also take into consideration a variety of extra factors, such as the debtor’s credit rating. However, you can get a better interest rate on your mortgage and eliminate private mortgage insurance by putting down a significant deposit and keeping your loan-to-value ratio low.
By gaining an understanding of your LTV ratio, you may better prepare yourself for the method of refinancing your loan and, ultimately, increase your chances of securing the most favorable terms.
