What is LTV and Why It’s So Important!
LTV is an initialism for Loan-to-Value. This describes the relationship between the amount that is financed and the value of a property.
If you have a house that is worth $250,000 and you have a loan on the house for $180,000, you would take the amount owed on the property and divide it by the value of the property.
For example,
$180,000 / $250,000 = 0.72
As you can see here the ratio explains the relationship. You have the loan($180,000) to value($250,000) and that is expressed as 0.72, or 72%. Your LTV is 72%.
This is one of the most important calculations when shopping for a mortgage loan because different programs have different eligibility when it comes to LTV.
For example, with a Conventional loan, the max loan to value that you can have without having to pay mortgage insurance is 80%. Anything above 80% LTV changes the terms and pricing of the loan.
Another example would be VA loan eligibility. If you are getting a VA loan you can finance up to 100% of the property, meaning that your LTV can be up to 100% on a purchase. For this specific program, you do not have to pay mortgage insurance no matter what your LTV is. Some people like to put money down to decrease the loan amount to keep the payment lower but that is pretty much the only benefit to putting money down on a VA loan.
LTV is also a big factor when it comes to pricing. You can have a conventional loan with 80% LTV and not have to pay mortgage insurance but it can be beneficial to know how LTV factors into pricing because it might save you more money in interest over the life of the loan. Pricing typically goes in bands of 5%.
For example, if you had two loans, one has an LTV of 80% and the other 74%, the one with 74% LTV will most likely have better pricing when it comes to rates as well as better rate availability. With pricing bands being in groups of 5% an LTV between 75% and 80% would be very similar if not the same rates and pricing. Once we move down into the next band, 70% to 74% you would have more favorable pricing and so on. This is because the lender is taking less risk by you putting more money down into the property. The thought process is that the more of your equity you have in the property, the less of a chance you have of walking away and not making your mortgage payments. The lender incentivizes the lower risk by offering favorable pricing.
This is also the same reason why lower mortgage terms have favorable pricing and rates. If you were looking at two conventional loans with one 30-year term and the other a 15-year term, the 15-year loan would have better rates. The lender can see that they will get their money back faster because you will be paying off the loan in half the time. The lender wants their money back as soon as possible because they want to put that money into other investments.
This wraps up what LTV is, how it is calculated, and the importance of how it applies to mortgage lending.
