If you haven’t heard of the loan to value ratio, also referred to as LVR, it plays a crucial factor when applying for a mortgage. This ratio is the amount of money you borrow from your lender, divided by the purchase price of the home, and then expressed a percentage.
For example, if the house you are considering buying is $250,000 and you plan to make a down payment of 20% which would be $50,000, that would mean your loan amount needed would be $200,000. This would then mean your LTV would be $200,000/$250,000 = 0.8, or 80%.
This may seem confusing to you at first but don’t worry, were about to make some more sense of this for you. Get ready to wow your friends with these loan to value facts.
Why the LTV Matters
Lenders use these ratios to determine the risk they face when loaning money to potential buyers. The bigger the LTV, the better chance there is of the borrower defaulting on the loan and failing to pay their monthly mortgage.
It is important to figure in the loan to value ratio in order to obtain more favorable mortgage terms and interest rates. However, this isn’t the only factor you should be paying close attention to. Credit scores also play a huge role when trying to calculate a mortgage rate.
Borrowers with high LTV ratios tend to appear riskier to lenders because then there is less equity invested in their homes. To make this simple, let’s say you are only able to put down 10% on that $250,000 home mentioned earlier. That’s $25,000. In other words, your loan to value ratio would be $225,000/$250,000 = 0.9, or 90%.
Most private lenders require borrowers to have an LTV ratio of 80% or lower to approve them for a loan. So, keep in mind that you should ideally be making a down payment of 20% or greater. First time home buyers and those struggling with their credit scores have a harder time meeting these criteria and are often deemed too risky.
However, there are exceptions. Sometimes a lender might approve a high LTV but at a higher interest rate. They could also suggest the borrower purchase a private mortgage insurance that would keep the lender safe in the event the buyer might default. This is also referred to as PMI and is typically required for loans with down payments less that 20%. So more than likely if you are a high LTV client this will almost always be mandatory. There may be another alternative in lowering your loan to value ratio.
Two Ways to Decrease Your LTV
NO. 1: MAKE A LARGER DOWN PAYMENT
Putting down at least 20% will create a desirable amount to mortgage lenders. This 20% is usually sufficient enough in lowering your loan to value ratio.
NO. 2. BUY A CHEAPER HOUSE
This may seem obvious, but it is by far the easier option for most. First look to see how much you can afford in a down payment. Let’s say that number is $25,000. So, in order to keep your LTV around that desirable 80% you should be looking at homes worth $150,000. This is because your mortgage amount would be $125,000 and $125,000/$150,000 = 0.83, or 83%.
Always make sure to discuss your options with a lender or realtor before you start your house hunting. If you get pre-approved, it will be that much easier to know what is within you budget. Utilize this formula and make sure to be fully educated about your LTV ratio.
