A Loan to Value or LTV in its shortened form is a ratio used by lenders to partially determine the risk factor of a mortgage. This is coupled with several other factors such as a borrower’s credit rating and financial history to determine if giving them a loan is worth it or not. During bad economic times this becomes even more important.
If the Loan to Value ratio is high then the mortgage risk factor is high and therefore more collateral may be taken under account, higher interest rates implemented and it will generally cost the borrower more to make it worth the lender’s while. It is better to get a low LTV mortgage if you have a bad credit score. A lender will not offer a loan without being completely certain they’ll get their money back with interest, whether it’s from collateral or successful repayment.
To calculate Loan to Value, the following formula is used:
/ = divided by
LTV = Mortgage Amount / Appraised Value of the Property.
Jeremy needs to borrow $130,000 to purchase a house appraised at $150,000
The Loan to Value ratio = $130,000 / $150,000 = 0.87 or 87%
A lot of financial lenders require the loan to value ratio to be no more than 75% so in this case Jeremy is likely to be declined a loan because the risk factor is too high. It is very rare to have a 100% mortgage, although it is not impossible. All lenders have their own terms and amounts.
Generally the property or house will be valued by an appraiser for its “fair market value assessment,” but if the buying process has begun then the calculation can be a lot more accurate as there will be an actual real value figure for you to work with.
If there are multiple mortgages (primary and secondary) a similar calculation called the Combined Loan to Value ratio is used to take all mortgages in to account.
Lenders use the Loan to Value ratio in conjunction with lots of different factors and it would be foolish to base a whole mortgage decision on the loan to value ratio.