The loan-to-value ratio, or LTV, compares your mortgage amount to a home’s value. Lenders use it to see how much you are borrowing relative to the property, and that can affect whether you qualify, whether mortgage insurance is required, and how sensitive your pricing and loan options may be.
For a home purchase, lenders generally calculate LTV using the lower of the purchase price or appraised value. For a refinance, they typically use the appraised value. That is why a low appraisal can change your loan amount, your required cash to close, or whether the loan still works.
Even if your credit, income, and savings are strong, LTV can still play a major role in the outcome of your application. It is one of the key ways lenders evaluate your down payment, your equity position, and your flexibility as a buyer or refinancer.
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.
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.
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.
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.
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.
If LTV becomes a problem, the next step is to focus on the few changes that can actually move the file forward.
If the appraisal comes in below the contract price on a purchase, the biggest change is that the lender will usually base LTV on that lower number. That can mean you need more cash to close, a revised offer, or a different financing plan.
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.
Sammamish Mortgage can help. We serve clients across Washington, Idaho, Colorado, Oregon, and California. Since 1992, we’ve been providing several mortgage programs and products with flexible qualification criteria to borrowers across the Pacific Northwest. Visit our website to get an instant rate quote or to use our online mortgage calculator. Or, reach out to us if you are ready to get pre-approved for a mortgage.
Loan-to-value ratio compares your loan amount to the home’s value. Lenders use it to measure risk, so a higher LTV can make approval more difficult and may lead to mortgage insurance, less favorable pricing, or fewer loan options. A lower LTV usually gives borrowers more flexibility.
In general, a lower LTV is better because it means you are borrowing less relative to the property’s value. Lower LTV often reflects a larger down payment or more equity, while higher LTV means less equity and more lender caution.
For a purchase, lenders generally calculate LTV by dividing the loan amount by the lower of the purchase price or the appraised value. If the appraisal comes in below the contract price, that lower appraised value is usually used.
For a home purchase, lenders generally use the lower of the purchase price or appraised value. For a refinance, they typically use the appraised value.
The basic formula is LTV = loan amount divided by home value. For example, if the loan amount is half of the home’s value, the LTV is 50 percent.
Higher-LTV loans usually involve more risk for the lender, so mortgage insurance may be required. Once the loan is paid down enough and the LTV falls below certain levels, mortgage insurance may no longer be required in many cases, although government-backed loans can keep insurance in place longer.
Yes, some mortgage programs allow higher LTVs than others. However, higher LTV can bring stricter underwriting, mortgage insurance, a lower approved loan amount, or less favorable pricing.
Yes. For a refinance, lenders typically use the appraised value to calculate LTV. For a purchase, they generally use the lower of the purchase price or appraised value.
If the appraisal is lower than the contract price, the lender will usually base LTV on that lower value. This can raise your LTV, reduce the loan amount you qualify for, require more cash to close, or force a change in the financing plan or purchase contract.
Buyers may be able to lower LTV by making a larger down payment, choosing a lower-priced home, or renegotiating if the appraisal is low. Refinance borrowers may improve LTV by waiting until they have more equity or until the property value increases.
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