Loan-to-Value (LTV) Ratio
What is the Loan-to-Value Ratio?
You will no doubt see LTV when looking for a mortgage. This is your loan-to-value ratio and it is the amount of the mortgage loan against the total appraised value of the property on which the loan is secured. If that doesn’t make sense, here is a better example.
Let’s say that the home you are looking to buy is valued at $350,000. With $50,000 down up front, the total mortgage loan would be $300,000. To determine your LTV, you would divide the loan amount by the total value, for an 85 percent LTV ratio.
| House Value | Down Payment | Loan | LTV Ratio |
|---|---|---|---|
| $350,000 | $50,000 | $300,000 | 0.85 (85%) |
| $450,000 | $0 | $450,000 | 1.00 (100%) |
| $200,000 | $100,000 | $100,000 | 0.50 (50%) |
For mortgage products like a home equity line of credit or line of credit mortgage, a loan-to-value ratio of lower than 80 percent is required. That means that you will have to build at least 20 percent equity in your current property.
Take this example. If you purchased your home 10 years ago for $380,000 and it has risen to $400,000 in value. When you made the purchase, you put 20 percent down and took out a mortgage of $304,000. Over the last decade, you have managed to pay down another $10,000 on the principal. That leaves your loan at $294,000, compared to your current market appraisal of $400,000. Divide the loan by the value and you come to a 73.5 percent loan-to-value ratio.
You can qualify to refinance up to 80 percent of your home’s loan-to value through a mortgage refinance or home equity line of credit. You can use those funds for anything that you choose, be it a renovation, investment, or major renovation.
Negative Equity
It is also possible for the property value to decrease. If it has done so significantly – due to a housing bubble burst – loan-to-value ratios can actually rise in excess of the property value.
For example, let’s say a buyer bought their home for $250,000 and put $12,500 down. After five years, the property depreciates by 10 percent. Now the property is valued at $225,000 and only $1,000 has been paid toward the principal of the loan over this time.
With the mortgage now standing at $238,000, divided by the $225,000 value, you would have a 106 percent loan-to-value ratio. That would be called negative equity in the home.
When you are home shopping, make sure that you have a qualified real estate professional on the job. They will perform a market analysis of the property you are thinking about buying. This is to determine the true market value and help protect you against potential negative equity. Keep in mind that on purchasing involving a loan-to-value of 80 percent or higher, mortgage default insurance will be required. That is another fee to add to your home buying budget.