Loan-to-Value Ratio: Definition & Formula

Instructor: Tara Schofield

Tara has a PhD in Marketing & Management

Understanding the loan-to-value ratio can help your clients understand how banks will evaluate their loan and one factor that will affect their credit rating.

What is Loan-to-Value Ratio?

Your clients want to buy a beautiful home in a neighborhood with great schools and parks for their children to play in. You've helped them find the perfect home but are not sure if it the bank will approve the loan.

The first thing they check is the loan-to-value ratio (LTV), a calculation that shows how much risk the bank is taking by lending money on a house. The higher the LTV ratio, the higher the risk. This may lead to the bank turning down the loan or charging a higher interest rate.

LTV Ratio Formula

The LTV ratio is equal to the mortgage amount divided by the appraised property value.

In the example above, your clients desired home appraises for $300,000. They will need a loan of $240,000. Plugging those numbers into the calculation, the LTV ratio =

$240,000 / $300,000 = 80%. Most conventional lenders want to see the LTV ratio 80% or lower and offer the best rates when the ratio is under 80%. The lower the LTV ratio, the better.

What Factors Affect LTV Ratio?

The three main factors that affect the LTV ratio are down payment, sales contract price, and appraised value. T

Down Payment

In the example above, there is a difference of $60,000 between the loan needed and the appraised price. One reason there may be a difference in those figures is the down payment, the money the buyers are paying out of their pocket at closing. The more the down payment, the lower the LTV ratio will be. Most lenders like to see 20% but may lend more than 80% if the buyer has excellent credit or assets.

Sales Contract Price

Another reason your buyers may only need a $240,000 loan is because the sellers are taking less than the appraised price for the home. The sales contract price is the price the buyer and seller agree on for the sale of the house.

Perhaps the sellers are anxious to sell or want to sell the house quickly and are willing to sell at a discount to do so. If the price is below the appraised value, the LTV ratio will be lowered (improved). While the sales contract price is not part of the LTV equation, it does affect the amount the lender will need to borrow (the mortgage amount).

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