Are you in the market for a new home? If you plan on using mortgage financing to buy your next home you’ve likely heard the phrase “loan-to-value” or the acronym “LTV” before. Let’s take a quick look at the loan-to-value ratio including why it’s important, how to calculate it and how it can affect your mortgage.
What is the Loan-to-Value or LTV Ratio?
In short, the LTV ratio is a number that compares how much money you
owe against your home with its resale value in the marketplace. A low
LTV ratio indicates that you have far more equity in your home than you
owe in mortgage payments; conversely, a high LTV ratio indicates that
you owe almost as much as your home is worth.
Calculating your LTV ratio is easy. Simply divide the amount that you
have (or will have) remaining in your mortgage by your home’s value.
For example, if you own a home worth $250,000 and you still owe $150,000
on your mortgage, the calculation would be $150,000 divided by
$250,000, which gives you a LTV ratio of 0.6 or 60 percent.
Why is the LTV Ratio Important?
Your LTV ratio is important for a number of reasons. First, your
mortgage lender will use this figure as part of their risk calculation
when they assess your financial suitability for your mortgage. If you’re
only putting 5 percent of the purchase price in as a down payment
you’ll have a LTV ratio of 95 percent, which is a more risky loan than
one with a LTV ratio of 30 percent and thus will almost certainly come
with a higher interest rate.
If you have a LTV ratio higher than 80 percent and you’re getting a
mortgage from a conventional lender you’ll also be required to pay for
private mortgage insurance or “PMI”. Although PMI rates generally sound
quite low – in the neighborhood of 0.5 to 1 percent – they can add
hundreds of dollars to your monthly mortgage payment. Note that PMI may
not apply to you if you’re seeking out a government-backed mortgage from
Veteran’s Affairs, the USDA or the FHA.
While the LTV ratio might seem simple, this number can affect your
mortgage in a variety of ways. Contact your local mortgage advisor today
to learn more about the LTV ratio and to have your questions answered
by an experienced professional.