When dealing with mortgages, either buying a home or taking equity out of your current one, your loan-to-value is crucial. This article explains what you need to know in simple terms.As with most matters of finance, there are exceptions, special cases, and other nuances that can affect you. We won’t go into all of the details here. Our goal is to give you an understanding, not throw a textbook at you.
Loan-to-value (LTV) is the amount you owe on your mortgage divided by the market value of your home. Think of it as how much of your home the bank owns.
As you make mortgage payments and as the value of your home rises (hopefully), your LTV falls, which is good. See the infographic below for a more detailed description
Cash Out Refinance Vs. Home Equity Loan
In the interest of brevity, this article focuses on the maximum LTV banks are allowed to provide. That doesn’t mean that they are willing to, however.
Keep in mind, that your max LTV differs depending on the purpose of the loan. The maximum LTV you can get for a purchase is 95% (5% down). However, you can’t refinance up to that much.
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How To Calculate Your Home Equity And Loan To Value (ltv) Ratio
Additionally, a loan with a high LTV ratio may require the borrower to purchase mortgage insurance to offset the risk to the lender. This type of insurance is called private mortgage insurance (PMI).
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An LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage. For example, if you buy a home appraised at $100, 000 for its appraised value, and make a $10, 000 down payment, you will borrow $90, 000. This results in an LTV ratio of 90% (i.e., 90, 000/100, 000).
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Determining an LTV ratio is a critical component of mortgage underwriting. It may be used in the process of buying a home, refinancing a current mortgage into a new loan, or borrowing against accumulated equity within a property.
Lenders assess the LTV ratio to determine the level of exposure to risk they take on when underwriting a mortgage. When borrowers request a loan for an amount that is at or near the appraised value (and therefore has a higher LTV ratio), lenders perceive that there is a greater chance of the loan going into default. This is because there is very little equity built up within the property.
As a result, in the event of a foreclosure, the lender may find it difficult to sell the home for enough to cover the outstanding mortgage balance and still make a profit from the transaction.
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The main factors that impact LTV ratios are the amount of the down payment, sales price, and the appraised value of a property. The lowest LTV ratio is achieved with a higher down payment and a lower sales price.
A LTV ratio is only one factor in determining eligibility for securing a mortgage, a home equity loan, or a line of credit. However, it can play a substantial role in the interest rate that a borrower is able to secure. Most lenders offer mortgage and home-equity applicants the lowest possible interest rate when their LTV ratio is at or below 80%.
A higher LTV ratio does not exclude borrowers from being approved for a mortgage, although the interest on the loan may rise as the LTV ratio increases. For example, a borrower with an LTV ratio of 95% may be approved for a mortgage. However, their interest rate may be a full percentage point higher than the interest rate given to a borrower with an LTV ratio of 75%.
Requirements For A Home Equity Loan Or Heloc In 2023
If the LTV ratio is higher than 80%, a borrower may be required to purchase private mortgage insurance (PMI). This can add anywhere from 0.5% to 1% to the total amount of the loan on an annual basis. For example, PMI with a rate of 1% on a $100, 000 loan would add an additional $1, 000 to the total amount paid per year (or $83.33 per month). PMI payments are required until the LTV ratio is 80% or lower. The LTV ratio will decrease as you pay down your loan and as the value of your home increases over time.
In general, the lower the LTV ratio, the greater the chance that the loan will be approved and the lower the interest rate is likely to be. In addition, as a borrower, it's less likely that you will be required to purchase private mortgage insurance (PMI).
While it is not a law that lenders require an 80% LTV ratio in order for borrowers to avoid the additional cost of PMI, it is the practice of nearly all lenders. Exceptions to this requirement are sometimes made for borrowers who have a high income, lower debt, or have a large investment portfolio.
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As a rule of thumb, a good loan-to-value ratio should be no greater than 80%. Anything above 80% is considered to be a high LTV, which means that borrowers may face higher borrowing costs, require private mortgage insurance, or be denied a loan. LTVs above 95% are often considered unacceptable.
For example, suppose you buy a home that appraises for $100, 000. However, the owner is willing to sell it for $90, 000. If you make a $10, 000 down payment, your loan is for $80, 000, which results in an LTV ratio of 80% (i.e., 80, 000/100, 000). If you were to increase the amount of your down payment to $15, 000, your mortgage loan is now $75, 000. This would make your LTV ratio 75% (i.e., 75, 000/100, 000).
FHA loans are mortgages designed for low-to-moderate-income borrowers. They are issued by an FHA-approved lender and insured by theFederal Housing Administration (FHA).
Home Equity :: Tri County Area Federal Credit Union
FHA loans require a lower minimum down payment and credit scores than many conventional loans. FHA loans allow an initial LTV ratio of up to 96.5%, but they require a mortgage insurance premium (MIP) that lasts for as long as you have that loan (no matter how low the LTV ratio eventually goes).
VA and USDA loans—available to current and former military or those in rural areas—do not require private mortgage insurance even though the LTV ratio can be as high as 100%. However, both VA and USDA loans do have additional fees.
Fannie Mae's HomeReady and Freddie Mac's Home Possible mortgage programs for low-income borrowers allow an LTV ratio of 97%. However, they require mortgage insurance until the ratio falls to 80%.
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For FHA, VA, and USDA loans, there are streamlined refinancing options available. These waive appraisal requirements so the home's LTV ratio doesn't affect the loan. For borrowers with an LTV ratio over 100%—also known as being underwater or upside down—Fannie Mae's High Loan-to-Value Refinance Option and Freddie Mac's Enhanced Relief Refinance are also available options.
Upfront fees on Fannie Mae and Freddie Mac home loans changed in May 2023. Fees were increased for homebuyers with higher credit scores, such as 740 or higher, while they were decreased for
