When you are deciding to purchase a house and need to be approved for a mortgage one of the factors that your lender will consider is your loan-to-value (LTV) ratio. If you are unfamiliar with the term, your LTV ratio is calculated by dividing the amount of your mortgage by the total value of your house. The loan-to-value ratio is stated as a percentage.
How Your LTV Has an Affect on You
Your lender will look at your LTV to determine your risk value in lending you money. The higher your LTV is, the riskier you appear to your lender. For example if you want to purchase a house valued at $300,000 and you make a down payment of $65,000 you would be looking for a mortgage of $235,000. Using the formula above, your LTV ratio would be 78%.
This number is used by lenders to determine what they think the likelihood is that you will default on your loan. Lower loan-to-value ratios mean that the homeowner has more equity in their home, which is more appealing to banks. Higher ratios make banks leery that down the line the homeowner will not have the ability to continue making payments.
Many traditional lenders, like banks, will not write a mortgage loan for LTV ratios that are higher than 80%. This means the buyer is required to make a 20% down payment. There is an option for lenders to write the loan even if it doesn’t meet their LTV requirement, but it will usually be at a much higher interest rate or with the requirement that you purchase Private Mortgage Insurance. Both of these options will cost you thousands of dollars over the life of your loan.
How to Improve Your LTV
While it is possible to lower your loan-to-value, there are only two options to accomplish it. The first one, which is the most obvious, is to come up with a larger down payment. This is usually easier said than down if you need to act quickly. Some buyers have family members that are able to gift them the funds to apply to their down payment.
If coming up with a larger down payment is not possible for you, your best option is to purchase a house that does not cost as much. If you have $60,000 to use as a down payment you might not be approved for a house valued at $400,000 since your LTV would be 85%. However, if you are to purchase a house valued at $200,000 your LTV drops to 70%, which makes you look like a better risk option to the lender.
Understanding the concept of loan-to-value ratio prior to being ready to buy puts you at a great advantage. You can take the time to save up for a down payment that will get you the complete package. With the right LTV ratio you can get the house you want at a great rate, while maintaining equity in the home.