Understanding Loan-to-Value and Down Payments

Jan 3, 2023 | Mortgage Guides

Mastering Home Financing: The Essentials of Loan-to-Value and Down Payments

Loan-to-value (LTV) is a ratio used by lenders to determine risk and set the loan terms. The higher the LTV, the riskier the loan, making rates higher. A lower LTV means less liability, resulting in more favorable rates for the borrower.

‍The downpayment is the portion of a loan paid upfront in cash. The larger the downpayment, the lower the LTV. This guide will further help you understand how loan-to-value ratios and down payments relate to your mortgage.

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What Is Loan to Value?

The loan-to-value ratio is the comparative measure between the appraisal value of the home and the mortgage. This ratio is often expressed by percent. ‍

Factors that Impact Loan-to-Value

The primary factors impacting loan-to-value are down payment, property value, credit score, type of loan, and debt-to-income ratio.‍

Down payment

Down payments are the biggest factor that impacts LTV. If the downpayment is 20%, the LTV is 80%. This is because the down payment is the funds being paid outright. Down payments build equity, and that means a lower LTV.‍

Property value

Loan-to-value is also reliant on the property value. Having a high appraisal is a two-edged sword for LTV. On the one hand, a higher market value than the loaned amount means that the LTV is advantageous because the mortgage is a smaller percentage of the assets. On the other hand, higher property values often imply a bigger mortgage.‍

Credit score

Borrowers with higher credit scores may be able to secure a lower LTV because they are creditable to the lender.‍

Type of loan

Different loans may have varied LTV requirements. For example, a conventional mortgage has a maximum LTV of 97%, while an FHA loan allows an LTV of up to 96.5%.‍

Debt to income

 A borrower with a high debt-to-income ratio may be less likely to qualify for a loan with a high LTV.‍

Benefits of a High Loan to Value

Having a high LTV has two benefits: lower down payments and being able to afford a better property.‍

Lower down payment

A high LTV ratio means that the borrower has to put less upfront money down, which can be helpful for borrowers who want to conserve their cash.‍

Acquiring more property

 A high LTV ratio may allow borrowers to afford a property of better value than if they had to make a larger down payment.‍

Benefits of a Low Loan to Value

In most cases, a lower LTV is better for both the lender and borrower. Some benefits of having a low LTV include lower interest rates, higher chances of approval, lower mortgage insurance, greater flexibility, and making the property easier to sell.

Lower interest rates

Lenders offer lower interest rates on loans with a low LTV because the borrower has more equity and is, therefore, a lower risk.‍

Higher approval chances

Borrowers with a low LTV ratio are more likely to be approved for a loan because they have more equity in their property. Similar to the above, the lower the risk, the more benefits the borrower will get.‍

Lower mortgage insurance

A low LTV means less apprehension about the borrower defaulting on their loan. This means private mortgage insurance (PMI) will be less expensive than with a high LTV.‍

Greater flexibility

Borrowers with a low LTV ratio have greater flexibility in their mortgage terms. This means securing more favorable terms on issues such as the length of the loan or the interest rate.‍

Easier to sell

Having a low LTV implies a potential seller has high equity, which makes the house easier to sell.‍

What is a decent LTV on a loan?

The appropriate LTV depends on various factors, such as the type of loan, the asset being purchased, and the borrower’s creditworthiness. 

‍However, borrowers may prefer loans with higher LTVs, as these loans may have lower down payment requirements and may allow the consumer to borrow more.‍

Calculating Loan to Value

To calculate the LTV, divide your current loan balance by your home’s appraised value. ‍

What Is a down payment?

A down payment on a house is a cash payment, or its equivalent when entering into a purchase contract. It is a percentage of the property’s price and is paid along with the balance in the form of a mortgage.

This payment counts toward the buyer’s equity.

How does a down payment affect a loan-to-value ratio?

The larger the down payment, the less one needs to borrow, which means the LTV ratio will be lower. The down payment always affects the LTV.‍

How much money do I need for a down payment?

In most cases, a minimum of 3% of the total is needed. However, 20% is recommended. Depending on the situation, a lower down payment might be considered, depending on factors such as property value, credit history, and DTI.‍

What are the closing costs?

Closing costs are fees incurred in the process of purchasing a property or obtaining a mortgage. These charges include title insurance, lender fees, appraisal fees, and other dues associated with the transaction. Closing costs vary depending on the property, the lender, and other factors.

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