The loan-to-value (LTV) ratio measures the percentage of a property’s value that’s being financed with a loan. Lenders typically set maximum LTV rates, which are often used by investors and homebuyers when budgeting for a project. The maximum LTV rates available to a borrower are based on the specific loan type, lender, as well as borrower qualifications.
Loan-to-Value (LTV) Formula
Calculating the loan-to-value ratio is relatively simple. We’ll walk you through the formula and go over each component below.
The loan-to-value (LTV) formula is:
LTV = (Size of Loan) / (Property’s Appraised Value)
Size of Loan
The size of the loan represents the amount that you borrow from the lender. Usually, lenders will set a maximum amount based on several factors such as borrower qualifications, the type of loan, and more. The size of the loan will dictate the amount of a borrower’s down payment and therefore his or her starting equity.
Property’s Appraised Value
The property’s appraised value is the valuation given by professional appraisers on your property. It does not necessarily equal the purchase price but is rather the estimated market value. Usually, appraisers consider several factors when appraising the property, including the property’s location, condition, and more.
Some lenders calculate the loan-to-value ratio based on the agreed purchase price instead of the appraised value. For example, if you agree to purchase a property for $100,000, a lender might offer you a 70% LTV ratio, meaning the loan size would be $70,000. The 30% (or $30,000) difference between the purchase price and loan amount would be your down payment.
Why the Loan-to-Value Ratio Is Important
The loan-to-value ratio is important because it helps a borrower set his or her maximum budget, expected down payment, as well as estimate the size of the monthly payments. Typically, lenders set maximum LTV as well as cap total loan amounts, which means that you’ll have to either find a property that fits within these limits or expect to invest a higher down payment.
A higher loan-to-value ratio means the lender is financing a larger portion of the property and is taking on more risk. A lower LTV means less of the property is being financed. Some borrowers want a high LTV because it means less money upfront. Others prefer a lower LTV since it means smaller financial obligation in terms of principal and interest payments and more starting equity.
Because of this, LTV is also an important consideration when it comes to refinancing a property and tapping into owner’s equity. With a lower loan-to-value ratio, you essentially put more money down and borrow less when you first purchase the property. This mean you have more home equity to start, which gives you refinancing options like home equity loans (HEL) and home equity lines of credit (HELOC) off the bat.
Pros and Cons of a High Loan-to-Value Ratio
LTV is a common measurement that most lenders use when determining the size of a loan. There are other ways in determining a loan size, such as the use of loan-to-cost ratio and after-repair-value ratio. A higher loan-to-value ratio means a higher loan size, and it has its pros and cons:
Benefits of a High LTV
- A high LTV means borrowers don’t need to invest a large down payment
- With a high LTV, borrowers can cover costs like new furniture or home improvements.
- A higher LTV gives borrowers more cash to invest elsewhere
Drawbacks of a High LTV
- A loan-to-value ratio means higher monthly mortgage payments
- Interest rates are also higher because you borrower more and the loan is riskier for lenders
- Property mortgage insurance is often required with a high LTV, and this is an additional cost
How to Increase LTV
Although a lower LTV means lower monthly payment obligations, there are some borrowers who prefer or need a higher LTV. This is because a higher LTV means less out-of-pocket cost. While the maximum loan-to-value ratios are set by the lender, there are still ways a borrower can increase the maximum LTV they can qualify for.
Below are 3 ways to increase your loan-to-value ratio:
1. Increase Borrower Qualifications
One of the biggest factors that can affect the loan-to-value ratio is your personal qualifications as a borrower. Typically, more qualified borrowers tend to get approved for a higher LTV. If you want to increase your LTV, you should focus on increasing things like your credit score, debt service coverage ratio (DSCR), liquidity, business experience for fix-and-flips and buy-and-rents, and more.
2. Look for Different Loan Options
There are different loan options that offer a higher loan-to-value, such as SBA loans, hard money loans, portfolio loans, and more. If your lender cannot provide you with the LTV ratio you need, it is best to shop around for other lenders that offer loans with higher loan-to-value ratios.
For example, SBA 7(a) loans typically have an LTV of up to 90%. Hard money loans can also often have a max loan-to-value ratio of 90%. And that’s not even to mention FHA loans, which have maximum LTV rates of 97%. If you’re currently looking at more traditional loans with max 80% LTV rates, you might want to look at some of these other options.
3. Consider Different Types of Properties
If the property that you are purchasing cannot qualify for a higher LTV, you may want to consider other types of properties that can be financed with a high loan-to-value ratio. For instance, apartment loans and multifamily loans might have a lower maximum LTV, while loans that finance single-unit, owner-occupied properties (like FHA loans) have a higher maximum LTV.
In addition, commercial real estate loans are typically financed with a lower LTV ratio. If you want to have a high loan-to-value ratio, you may want to look into smaller properties that are residentially zoned instead.
Reasons to Lower the LTV Ratio
A low loan-to-value (LTV) ratio isn’t bad. In fact, a lower LTV means you borrow less, making your monthly payments lower. Also, some lenders provide lower interest rates if the LTV is lower, which means that you’ll pay less in overall interest, too. It can be a good idea to get a lower LTV and put a higher down payment on the house if you have the cash or means to do so.
Below are few of the reasons why a lower LTV ratio might be better for you as a borrower:
- Low interest rates – A high loan-to-value ratio is likely to come with a higher interest rate, considering the risk for lenders. Most lenders, however, will offer lower interest rate for lower LTV ratios.
- Higher starting equity– As a borrower, you’ll own more of your property off the bat, giving you more leverage when it comes to refinancing as well as a greater opportunity for price appreciation of the asset.
- No private mortgage insurance (PMI) – Usually, a high LTV ratio would require you to pay for monthly mortgage insurance, which is an added cost for you.
When financing a property, loan-to-value ratio is often used to determine the size of loan. A high LTV is advantageous to the borrowers in the sense that they do not need to invest a large down payment. However, some borrowers prefer a lower LTV because this makes their interest rates and monthly mortgage payments much lower.