The loan-to-value ratio, or LTV, is an important concept for home buyers and homeowners in Washington State. For buyers, it can affect everything from your chances for mortgage approval to the amount you have to put down on your loan. For homeowners, it can affect your ability to refinance and determine whether or not you need mortgage insurance.
But what is the loan-to-value ratio, exactly? And what does it mean for Washington home buyers and homeowners? Here’s a crash course in the LTV.
Definition of Loan-to-Value Ratio
As you might have guessed, the loan-to-value (LTV) ratio is a percentage that allows lenders to compare the amount of your mortgage loan with the the appraised value of your home.
Example: If a homeowner currently has a mortgage loan with a balance of $200,000, and the home itself is valued at $250,000, then the LTV would equal 80%. (Because 200,000 is 80% of 250,000.)
To calculate the LTV you would simply divide the mortgage amount by the home’s value, and then convert the resulting decimal into a percentage.
How Does the LTV Affect Home Buyers?
When buying a home in Washington, you’ll be able to choose how much of a down payment you want to make. The different mortgage loan programs have different requirements, as to the minimum down payment. It might be as low as 3% on a conventional home loan, or 3.5% for an FHA-insured mortgage. (Or even 0%, if you happen to qualify for the VA loan program.)
The down payment is directly related to the loan-to-value ratio. Putting more money down will result in a lower LTV, while making a smaller upfront investment will lead to a higher LTV. And that’s where insurance comes into the picture.
When a homeowner’s loan-to-value ratio rises above 80%, mortgage insurance is typically required. This unique kind of insurance protects the lender from potential losses relating to borrower default. The 80% rule is a long-time industry requirement.
While mortgage insurance protects the lender, it’s the borrower / homeowner who actually pays for the coverage. This is why many home buyers in Washington choose to make down payments of at least 20% when buying a house. They do it to keep the LTV at 80% or below, thereby avoiding the threshold where mortgage insurance is required.
PMI for conventional loans can usually be cancelled later on, when the LTV drops to 80% or below. But that’s not the case for FHA loans. Most home buyers who use the FHA program to finance their purchases have to pay their annual mortgage insurance premiums (MIP) for the life of the loan.
The LTV can also affect a home buyer’s chances for mortgage approval. A higher loan-to-value ratio represents a bigger risk to the bank or lender that makes the loan. A smaller LTV, on the other hand, is generally viewed as a lower risk to the lender. So the criteria for mortgage approval can sometimes be more stringent when there’s a higher loan-to-value.
A Summary of Key Points
We’ve introduced a lot of mortgage terminology and concepts here. Here’s a quick recap of the key points you should know about LTV ratios:
- The loan-to-value ratio allows lenders to compare the amount of your mortgage with the appraised value of the property.
- The LTV is important for both purchase transactions (for home buyers) and refinance transactions (for homeowners).
- Loan-to-value is one of the most important factors when it comes to mortgage underwriting and approval. A higher LTV might come with stricter criteria for the borrower, because it brings a higher level of risk.
- When the loan-to-value ratio rises above 80%, mortgage insurance is usually required. PMI for conventional loans can typically be cancelled later on, when the LTV drops to 80% or below. The annual insurance premiums for FHA-backed mortgages are usually paid for the life of the loan.