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Understanding Loan-to-Value Ratios

We will explore loan-to-value ratios (LTV ratios) in depth. After reading this article, you’ll have a thorough understanding of this important financial metric and how it impacts borrowing decisions.¬†

What is a Loan-to-Value Ratio?

A loan-to-value (LTV) ratio compares the amount of a loan to the total value of the asset being purchased. It is calculated by dividing the original loan amount by the appraised asset value or purchase price.

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For example, if you’re taking out a $100,000 mortgage loan to buy a home appraised at $200,000, your LTV ratio would be:

$100,000 (Loan Amount) / $200,000 (Home Value) = 50%

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So in this case, the LTV ratio is 50%. This means that the loan amount is financing 50% of the home’s total value. The remaining 50% is being paid with a down payment.

LTV ratios are an important consideration for both lenders and borrowers. They provide a simple measurement of risk – the higher the LTV ratio, the riskier the loan is for the lender. For borrowers, lower LTV ratios generally mean better interest rates and terms.

When is an LTV Ratio Calculated?

LTV ratios are calculated at different stages of the borrowing process:

Origination LTV: This ratio is calculated when the loan is first taken out, based on the initial loan amount and property value. It sets the baseline risk level for the lender.

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Ongoing LTV: If property values change over time, lenders may recalculate the LTV ratio to check if additional collateral is needed. A declining ratio means the borrower’s equity is increasing relative to the loan balance.

Refinance/Modification LTV: When refinancing or modifying a loan, the current LTV ratio comes into play. Borrowers may need to bring more money to the table if the ratio has increased.

Foreclosure/Liquidation LTV: Sadly, if a borrower stops paying and the property needs to be sold, the final LTV ratio at liquidation matters greatly to lenders. The higher it is, the bigger the losses may be.

So in summary – LTV ratios are snapshots of risk taken at key points in a loan’s lifecycle from origination to potential liquidation.

How LTV Ratios Affect Borrowing Terms

LTV ratios play a major role in determining the terms and pricing of a loan. Here are some of the key ways they impact borrowers:

Interest Rates

The lower the LTV ratio, the better the interest rate typically is. There is less risk to the lender when more of the property is owned outright by the borrower versus financed.

Down Payment Requirements

Mortgage programs often specify minimum down payments needed to achieve certain LTV tiers – e.g., 20% down for LTV at or below 80%. Less money down means a higher LTV and riskier loan.

Private Mortgage Insurance

If the LTV exceeds a certain threshold like 80-85%, private mortgage insurance is usually required. This insurance protects the lender if the borrower defaults.

Loan Program Eligibility

Some loan programs are only open to applicants meeting specific LTV levels. Higher ratio loans may only be possible with certain government-backed financing.

Refinance Opportunities

It’s harder or impossible to refinance a loan when the current LTV is very high due to a lack of equity or rising rates. More equity means more options.

So in summary – borrowers should aim for the lowest possible LTV ratios to qualify for the most favorable loan programs, rates, and terms over the life of their financing.

Common LTV Ratio Thresholds

Lenders have established normative LTV ratio benchmarks based on historical loss data. Here are some of the most common thresholds used in mortgage lending:

80% LTV: This is the pivotal mark for many standard conforming loans. Rates are best below 80% LTV without mortgage insurance.

85% LTV: Above 85% usually requires private mortgage insurance (PMI). Loans are seen as higher risk, so terms are less favorable.

90% LTV: Only available through certain government-backed programs. These loans are the riskiest profile, with the worst rates.

97-100% LTV: Rare “jumbo” loans with no/minimal down payment but expensive pricing due to high risk of defaults.

103-105% LTV: Only possible with seller-funded down payment assistance programs in some areas. Considered very high risk.

The goal post-financing should usually be getting the LTV below 80% as soon as possible through on-time principal payments. This removes the requirement for costly PMI over time.

How LTV Ratios Impact Various Loan Types

Different types of loans have their own tolerances and underwriting guidelines tied to LTV ratios:

Conventional Loans

Most conforming loans require 5% down for 95% LTV, 10% down for 90% LTV, and 20% down for 80% LTV or better without PMI. Jumbo loans have stricter LTV limits.

FHA Loans

FHA loans allow 96.5% LTV for borrowers putting only 3.5% down. This program expands access but with higher mortgage insurance costs.

VA Loans

The VA program does not require a down payment at all for eligible veterans. However, funding fees are tied to the LTV, so the higher it is, the more expensive the fees.

USDA Loans

USDA Rural Development loans permit 100% financing in eligible rural/low-income areas. Strict income limits apply versus moderate LTV ratios.

Portfolio/Hard Money Loans

These non-conforming loans from individual investors may go to 75-90% LTV, but rates are higher due to elevated risk profile.

So in choosing a loan, borrowers should factor in their LTV ratio eligibility under standard guidelines for each program type. Some flexibility exists, especially in hot markets.

Common Ways to Improve an LTV Ratio

For borrowers looking to enhance their positioning for a home loan, there are a few different approaches to lowering an LTV ratio:

Make a Larger Down Payment – The more cash invested up front, the lower the ratio will be from the start. 20% down achieves optimal ratios.

Pay Down Principal Early – Extra payments directly reduce the loan balance over time, improving the ratio without changing the home value.

Get the Home Reappraised – If property values increased substantially, requesting a new appraisal could enhance collateral backing the loan.

Take Out a Home Equity Line – Withdraw a portion of accumulated equity for renovations/debt and count it in the ratio calculation.

Seller Credits at Closing – Some sellers will provide cash in certain scenarios to help buyers hit LTV hurdles.

Lower the Purchase Price – Negotiating a discounted price can directly yield a more optimal LTV ratio at origination.

The bottom line is with some creativity and effort, borrowers can often position themselves for better loan outcomes linked to improved LTV positions.

LTV Ratios and the Housing Market Cycle

Interestingly, LTV ratios tend to fluctuate alongside the overall housing market cycle as both lenders and borrowers adjust their approach:

Rising Market (Early Phase)

As home prices accelerate, lenders relax lending standards to fuel more transactions. Lower down payment loans with higher LTVs become more obtainable.

Peak Market

Luxury buyers push the envelope with ultra-high LTV financing of 90-100% for trophy properties. Rates are very low, and underwriting is loose. Overbuilding may occur.

Declining Market (Contraction)

When sales begin to soften, lenders restore prudent underwriting by tightening LTV limits, raising rates, and getting finicky about documentation.

Market Bottom

Rates on higher LTV loans are extremely punitive if available. Only investors seeking steals still borrow at 90%+ LTV due to depressed property values.

Early Recovery

Conforming loans start relaxing guidelines again on balance once sales come around. LTVs drift higher slowly alongside recovering home prices.

So LTV tolerance also tends to be cyclical based on optimism/pessimism about housing demand. Lenders extend leverage in good times but clamp down when uncertainty arises.

Real-World LTV Ratio Examples

Here are some hypothetical scenarios to illustrate how specific LTV ratios may play out in practice:

New Purchase at 90% LTV: A borrower makes a 5% down payment of $10,000 on a $200,000 home. Their mortgage amount is $180,000, yielding an LTV of 90%. Private mortgage insurance is required.

Refinance from 95% to 80% LTV: Over five years of payments, home values rose, and the loan balance fell. A borrower refinances a $190,000 loan on a new $200,000 home, putting $40,000 down from savings to get an 80% LTV. This removes the requirement for private mortgage insurance.

USDA Loan at 100% LTV: A low-income family qualifies for a USDA Rural Development loan in an eligible rural area. With no down payment needed, their $150,000 loan amount results in a 100% LTV.

Portfolio Loan at 85% LTV: Investors approve a non-QM loan to a self-employed borrower for a rental property rehab. Based on the estimated $250,000 value after repairs, they lend $212,500 for an 85% maximum LTV

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