Ins and Outs of Loan-To-Value Ratio and Tips to Improve Your LTV Ratio

The Loan-to-Value Ratio Formula: Calculating Your Borrowing Power

In the mortgage and real estate industries, the term "loan-to-value ratio" is commonly used, but what does it mean & why is it crucial? Your LTV determines your interest rate and mortgage eligibility. It compares your mortgage to the home's appraised worth. A good LTV indicates property equity and lower lending risk. A poor LTV indicates little equity and may result in higher interest rates or mortgage rejection. 

What is the Loan-To-Value (LTV) Ratio? 

Divide your loan amount by your property's expected value to get the LTV ratio. 80% or less is often a decent LTV ratio. This implies that you are taking out a mortgage for no more than 80% of the home's worth and making a down payment of at least 20%. Lenders view this as less hazardous because you have greater equity in the house. If you default on the loan, the lender can recover most of the mortgage by foreclosing and selling the property. 

  • An LTV over 95% is typically seen as bad since you have little equity or "skin in the game." If property prices fall, you may owe more than the home is worth. Higher interest rates and costs are charged on high-LTV loans because lenders consider them riskier. 

  • In order to approve a mortgage, lenders assess the LTV ratio. The lower your LTV, the greater your chances of securing a mortgage and a cheaper rate. LTV stability provides you additional financial freedom and consistency during the life of your loan

How do you Calculate Your Loan-to-Value Ratio?

Now, we will explore how to calculate your LTV ratio:

                                 

Gather Your Loan and Property Details 

First, find your current loan balance and your property's estimated market value. Check your latest mortgage statement for the loan amount. Use a recent appraisal or compare the property value to similar homes currently listed or recently sold in your neighborhood. 

Apply the Formula 

The loan amount should then be divided by the property's value. 

What the Numbers Mean 

  • Under 80% is typically considered a good, low-risk LTV for lenders and indicates you have equity in the property. 

  • Between 80 and 95% is average but less ideal as you have little equity or are close to owing as much as the property is worth. 

  • Over 95% is usually seen as a high, risky LTV with little equity to protect the lender if you default on the loan. 

To improve your LTV, make additional principal payments to lower your balance or work to increase your property value through home improvements. Keeping an eye on your LTV and prioritizing building equity will put you in a better position financially in the long run. 

What is the original LTV formula? 

The original LTV formula is quite simple. It is calculated by dividing the total lifetime value of a client by the organization's average customer lifetime. 

 LTV = Total Customer Lifetime Value / Average Customer Lifetime 

Total Customer Lifetime Value

It refers to a customer's total revenue during their entire relationship with your company. It includes the initial sale amount plus any subsequent purchases, subscriptions, or other payments. Customers with more extended stays and more purchases have greater lifetime values. 

To calculate a client's lifetime value, you must first identify their customer lifetime—how long they pay. This could be months, years, or even decades for some loyal customers. Then, calculate the total amount they've spent over that period. Add up all purchases, subscriptions, service fees, and any other revenue they've generated. 

Average Customer Lifetime 

This refers to the average lifespan of all your customers. Some remain six months, others five years. Total client lifetimes are added and divided by total customers to calculate the average. The average provides a baseline against which to compare individual customer lifetime values. 

A higher LTV means a customer is more valuable to your company over the long run. Companies aim for the highest LTV possible while keeping customer acquisition costs low. The original LTV formula provides a simple way to determine which customers are the most profitable so you can focus your efforts on keeping them happy and loyal. 

What is a Good Loan-To-Ratio Value? 

A good LTV ratio suggests you have enough equity in the home to get a mortgage and a safety net. Overall, an LTV ratio below 80% is ideal. The down payment must be 20% of the buying price. You'll likely qualify for the best mortgage rates at this level since lenders see you as less risky. 

An LTV over 95% moves into risky territory. At this point, you are borrowing nearly the entire purchase price, leaving little buffer for potential value drops. Lenders also view these loans as riskier, typically charging higher interest rates. If values decline even slightly, you could end up owing more than the property is worth. While an LTV this high may allow you to get into a home with little money down, the extra costs and risks often outweigh the benefits for most buyers. 

For the optimal balance of down payment affordability and mortgage costs, aim for an LTV between 80 to 90%. This provides a good equity cushion, allowing you to get a mortgage with a 10 to 20% down payment. At these LTV levels, you can often find interest rates that won't break the bank while gaining peace of mind from the equity in your new home. 

What is a Bad Loan-To-Value Ratio? 

An LTV ratio exceeding 80% of the property's value is considered unfavorable. This means you have borrowed a large portion of the home's worth, leaving little equity in the property. While an LTV of 95-97% may allow you to put little money down, it's risky for you and the lender. 

Why is a high LTV risky?

Little home equity leaves you vulnerable if property values decline or you need to sell soon. If you default, the lender may not get enough money from selling the property. Lenders charge higher interest rates for high LTV mortgages to offset this risk. 

  • High LTV equals higher interest rates, which increases loan expenses. 

  • High LTV mortgages may be difficult to refinance to lower rates. 

  • If property values drop significantly, you could end up owing more than the home is worth (known as being "underwater"). 

  • If you need to relocate, you'll need cash to close the mortgage gap, making it difficult to sell the house. 

LTVs under 80% are ideal. This involves putting 20% down on the purchase. Get a lower interest rate, pay less interest, and have a financial cushion for market changes. Try 70-75% LTV or lower for the best rates and terms. 

While a lower LTV is better, don't despair if you can only put 10% down, for example. Many lenders offer mortgage insurance to cover the added risk, allowing you to get approved for an LTV over 80%. You can always choose to make additional principal payments to lower your LTV over time and eventually drop the mortgage insurance. 

LTV Ratio vs Combined LTV: What's the Difference? 

The lower your LTV ratio, the less risk for your lender—and often, the lower your interest rate. But did you know there's another ratio that provides an even fuller picture of your financial risk? 

Combined LTV Ratio 

Your mortgage and other loans secured by your property, such as a home equity line of credit, are part of your total LTV ratio. 

  • The LTV ratio is 86% ($250,000 ÷ $350,000)

  • When considering a $200,000 mortgage, $50,000 HELOC loan, and $350,000 property, each ratio is 57% (200,000 ÷ 350,000). 

  • LTV only considers your mortgage 

  • Combined LTV includes all debts secured by the property 

  • The lower the ratio, the less risk for lenders and the better for you 

  • An excellent combined LTV ratio is usually 80% or less. 

The lower your ratio, the more equity you have in the home and the less likely you are to owe more than it's worth if values drop. A higher proportion, say over 95%, could mean trouble refinancing or getting a reasonable rate in the future. 

The Bottom Line

Now you understand your LTV ratio. You know how to calculate it, what a good ratio is, and what's bad. With this knowledge, you can better bargain with lenders and decide how much to borrow for your mortgage. 

Learn your LTV and combined LTV ratios. The combined ratio shows lenders how much you owe compared to the value of your house, which may limit your ability to refinance or borrow more. A healthy combined LTV is best for long-term financial health and property wealth. 

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17 Nov, 2023

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