How Your Loan-To-Value Ratio Affects Your Mortgage Application

June 3, 2020
Last updated:
January 27, 2022
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The loan-to-value ratio measures the mortgage amount against total home value. The property is collateral to be seized in the event of foreclosure. If the loan amount exceeds 80 percent of the value, the lender bears a greater risk of losing money on a re-sale. Mortgage insurance, higher rates, and stricter terms are sometimes exchanged for high LTVs.

You have done everything right. Maintained steady employment, built up savings and retirement reserves, and always paid the bills on time. How is it you do not qualify for the mortgage you applied for? The fact is that the decision might have less to do with the applicant and more to do with the house you want.

The good name and history of the borrower can not by themselves turn a property into acceptable collateral. Even the best prospective mortgagors represent a risk of some kind to lenders, especially in hot markets like Washington, Oregon, Idaho, or Colorado. The ability to mitigate that risk is best measured by the loan-to-value ratio.

Collateral: Peace of Mind for Bankers

In general, collateral is an asset owned by the borrower that can be assumed by the lender in the event of default. In the case of home loans, collateral is the subject property to be either purchased or refinanced. In truth, collateral is required because banks and finance companies must consider the worst-case scenario — the borrower stops making the payments to which he or she is obliged.

Under such circumstances, the lender would seize the property and sell it to recoup its losses, either in part or as whole. To be sure, whoever makes the loan would rather have your money than your house. Foreclosure and resale are big operational expenses. On the flip side, such costs are small compared to simply writing a bad loan off.

After all, for a variety of reasons, excellent applicants turn into unreliable customers every now and then, especially in areas where homes are expensive like Washington, Colorado, Idaho and Oregon. Collateral is a hedge against this possibility. For collateral to serve its purpose, then, it must represent value that is sufficient to compensate for the loan’s outstanding balance.

A customer can not give a Rolex watch as collateral for a $300,000 outlay by a bank. The subject property is the only thing that might be sufficient security for such a large financial extension…with “might” being the operative word. Turning “might” into “will” happens when the loan-to-value ratio is determined to be acceptable by the lender.

How Is Value Ascertained For Homes?

There are two figures that point to the value of a piece of real estate. One is the agreed-upon purchase price; the other, the appraised market value. Of course, the appraisal is the only authoritative source when a house is being refinanced. In a purchase scenario, however, the lender will evaluate the property by selecting the lower number between sales price and appraisal.

A certified appraiser conducts a methodical process that leads to a dependable estimate. Measuring square footage, diagramming the floor plan and counting the number of rooms is a standard operating procedure, as is accounting for luxuries — pools or saunas. e.g. — appliances and household infrastructures like plumbing and electricity.

In addition to these very objective observations, appraisers rely on knowledge and experience to determine the condition of the house and the value of any improvements. Backing these conclusions up with photographs, appraisers fill out their reports by comparing the subject to similar homes in the same vicinity.

These comparable properties, or “comps,” are usually recent sales, the records of which appraisers obtain from county registers and multiple listing services. Looking at the sales prices for comps, appraisers adjust subject property values according to differences with those other properties. Important to note is those appraisal findings are pooled into a central database to prevent fraud and assure quality.

How Is Loan-To-Value Determined?

Occasionally, when buying a home in Washington, Oregon, Idaho or Colorado an appraisal comes in under the sales price — bad news for the buyer. Why? The amount qualified for under the guidelines of that particular loan product is restricted by the lender’s accepted value.

As an equation, the loan-to-value (LTV) ratio is the quotient of the proposed amount over the value of the house. An easy example is a property worth $300,000 and a loan amount of $150,000. This represents an LTV of 50 percent. With almost any mortgage offer, this LTV would easily meet the criterion with room to spare. Most requests, however, come much closer to the allowable threshold.

A conventional (no government guarantee), conforming ($510,000 or under) mortgage requires an 80 percent maximum LTV. A government-guaranteed loan is often more flexible; many of them allow up to 96.5 percent LTV. Not for free, though.

Mortgage products that accommodate high LTVs assume a greater hazard than the 80 percent and below the restriction. To offset this risk, lenders require mortgage insurance, charging a premium that is escrowed with each monthly payment.

This coverage compensates the bank if the borrower defaults. Once the loan is adequately paid down and the LTV dips below 80 percent — in many cases — the borrower is no longer required to carry this protection. Government loans preserve insurance for much longer.

big drawback to mortgage insurance is that the escrowed payments figure into a different ratio known as debt-to-income. The premium portion inflates the mortgage remittance thereby enlarging the monthly debt burden.

Is LTV the Most Important Factor in Mortgage Approval?

There are any number of variables and measures that can sink or save a mortgage application. Bad credit, false claims, insufficient assets, unverifiable employment or home inspection failure are among the hills on which a loan can die. As noted above, nevertheless, LTV goes to the heart of the lender’s security: collateral.

When this ratio is higher than ideal, a lender might reject an application or be more rigorous with other standards. Alternatively, they will agree to a lower loan amount or a higher interest rate. Ultimately, LTV must show some skin in the game for the borrower. As a mortgage is a secured loan, LTV tells the underwriters just how secure the loan will be.

How Can an Applicant Improve the LTV Position

For buyers, one way to present a better LTV to a lender is to find a cheaper house. A 20 percent down payment on a $400,000 house is less than a 20 percent deposit on a $750,000 property. If downsizing desires and expectations are possible, do it and the LTV will thank you.

Another avenue is to augment the down payment. Granted, money does not grow on trees but many home buyers have various savings funds applied to one or more goals. Drawing from other accounts, or receiving gifts from others, can put you in a stronger position relative to how much you bring to settlement.

Refinance customers can delay the transaction until they build up more equity and/ or the house appreciates in value. Yes, they risk an unfavorable shift in rates. At the same time, a stronger LTV promises better terms than a weaker one.

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Take Advantage of Knowledge and Expertise

There are many options concerning how to handle loan-to-value issues. Making the right choice depends on getting the most accurate and exhaustive information. Mortgage loan officers with extensive backgrounds and know-how are the best resources for decision-making at the start of a loan process. The best solution is to hire a knowledgeable professional who can help you get on the right track.

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Need a Home Loan?

Do you have questions about mortgages? If you have any doubts or questions about mortgages or refinancing, Sammamish Mortgage can help. We have been helping borrowers in Washington, Colorado, Idaho, and Oregon secure mortgage programs since 1992, and we’d love to help you too. Feel free to contact us to get a Rate Quote or Apply Instantly, and before you even get started, you can check out our View Rates on our website.

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