What is loan-to-value ratio?

Key points

• Loan-to-value ratio compares the amount of a loan with the value of the asset being used to secure it.
• Lenders prefer a low LTV ratio, since it represents less risk. They see a high LTV ratio as riskier.
• LTV ratio commonly comes into play when you’re applying for a mortgage. It compares your mortgage amount to the appraised value of your home.

Loan-to-value (LTV) ratio is a number that lenders consider when deciding whether to approve a secured loan. It compares the loan amount with the value of the collateral being used to secure it, whether that’s a house, car or another asset. A high LTV ratio is seen as riskier from the lender’s perspective, while a low LTV ratio is less risky.

Because lenders prefer to minimize risk, they may offer more competitive rates on low-LTV ratio loans. That’s why increasing your down payment can get you a better mortgage rate when you’re buying a home: A larger down payment means a lower LTV ratio on your mortgage, which in turn could mean better rates from a lender.

What is loan-to-value ratio?

Loan-to-value ratio is a number that compares the amount of a loan with the value of the asset being used to secure it. This value typically takes the form of a percentage.

In the world of real estate, where LTV ratio is commonly used, this number compares the amount of a mortgage to the appraised value of a home. If you took out a mortgage for $75,000 on a $100,000 home, for example, your LTV ratio would be 75%, since you’d be borrowing a home loan for 75% of the value of the home.

Mortgage lenders prefer a lower LTV ratio to a higher one, because it appears less risky. A lower LTV means you have more equity built up in your home. As a result, the bank has a better chance of recouping its losses if you were to default on your mortgage.

“A good loan-to-value ratio is within 80% and below,” says Certified Public Accountant Mark Stewart. “The lower your loan-to-value ratio, the higher your chances of getting your mortgage request approved.”

You could still take out a mortgage with a high LTV ratio, though. In fact, some lenders let you borrow up to 97% of the value of your home, meaning you could make just a 3% down payment. Higher LTV loans, however, tend to have higher interest rates.

Plus, you’ll likely have to pay private mortgage insurance if your LTV ratio is higher than 80%. PMI adds an average of $30 to $70 for every $100,000 borrowed to a homeowner’s monthly costs. You’ll have to keep paying it until you’ve built up at least 20% of equity in your home.

How does loan-to-value ratio work?

Lenders consider your LTV ratio when evaluating your application for a secured loan, such as a mortgage. When you buy a home, you typically put down a percentage of the sale price as a down payment. Assuming you’re borrowing a mortgage to pay for the rest, your lender will also send out an appraiser to determine the property’s value. (Note that the appraised value may or may not match the purchase price.)

Once the appraiser has determined the home value, the lender can calculate your LTV ratio. If you’re making a down payment of 10% of the home value and borrowing the rest, your mortgage’s LTV ratio will be 90%. If you’re making a down payment of 20% of the home’s value, your mortgage LTV will be 80%. The higher your down payment, the lower your LTV ratio will be.

Homeowners who qualify for special financing, such as a VA loan or USDA loan, may qualify for a 0% down payment, meaning they could take out a mortgage with a 100% LTV ratio. Everyone else, however, must cover some of the home cost upfront so their LTV ratio is 97% or lower.

What is the loan-to-value ratio formula?

LTV is calculated by dividing your current loan balance by the current appraised value of the asset securing your loan, whether that’s your home, vehicle or another piece of collateral.

You can use the following formula to calculate loan-to-value ratio:

Current loan balance / current appraised value = LTV

Let’s say, for example, you have a loan balance of $300,000 on a home that appraised for $400,000. Here’s how you would use the formula to calculate your LTV:

$300,000 / $400,000 = 0.75

When you convert 0.75 to a percentage, you get an LTV ratio of 75%.

Note that your LTV ratio will change as you pay off your mortgage and your home value changes. As your mortgage balance decreases, your LTV ratio could go down, as well. You could also see your LTV ratio drop if your home value goes up.

Tip: Keeping tabs on your LTV can be important if you’re paying PMI, the charge that comes into play when your LTV ratio is higher than 80%. Once your LTV drops below 80%, you can usually stop paying PMI and will see your monthly mortgage payment become more affordable as a result.

How is a loan-to-value ratio used by lenders?

LTV ratio is one risk assessment that lenders rely on when evaluating you for a loan. Lenders typically assign better interest rates to loans with lower LTV ratios. If you’re buying a home, making a bigger down payment could get you a better interest rate on your mortgage.

LTV ratio isn’t the only factor that lenders look at when evaluating your application for a loan, however. They also look at your credit score, debt-to-income ratio, payment history and income to assess your risk as a borrower.

If you’re going into the home buying process, taking time to improve your credit and reduce your debt-to-income ratio may help you secure better rates.

What is a good loan-to-value ratio?

When it comes to a good loan-to-value ratio for a home loan, the traditional advice is to aim for an LTV of 80% or lower so you don’t have to pay PMI. That typically goes hand in hand with making a down payment of 20% or higher when you purchase the home.

With this approach, you might get a lower interest rate on your mortgage, which could lead to thousands of dollars in savings over the life of your home loan. Avoiding PMI could result in even more savings.

That said, a lot of homeowners can’t afford to put down 20% upfront. According to the National Association of Realtors, the typical down payment for first-time homebuyers is just 6% to 7% of the purchase price. Since home prices typically increase on a year-over-year basis, it might not make sense—or be feasible—to wait until you have a 20% down payment saved up.

If you’re ready to become a homeowner now, you could put down a smaller down payment and borrow a mortgage with a higher LTV ratio. While you might get a higher interest rate and have to pay PMI, you can also start building equity sooner, which may pay off in the long run. (You could also refinance your mortgage down the road, ideally to a lower interest rate).

LTV vs. CLTV

LTV ratios can also be limited, since they only compare a single mortgage loan with the value of your property. If you have a home equity loan or line of credit, often referred to as a second mortgage, a lender may instead look at your combined loan-to-value (CLTV) ratio.

The CLTV ratio considers any loans you’ve taken out against your home. Let’s say, for example, that you borrowed a primary mortgage of $80,000 for a home that’s worth $100,000. You also took out a $10,000 home equity line of credit. In this situation, your LTV ratio would be 80%, but your CLTV would be 90%.

Lenders may consider the more inclusive CLTV ratio if you owe multiple debts on your home.