When exploring the idea of buying a new home, especially if you're a first-time homebuyer, expect to face many decisions, the most important of which are financial. Obviously, you'll want to secure a home loan with a low interest rate so your monthly mortgage payment is in line with your budget. To do that, you should scan up your credit report and fix any issues, try to improve your credit score (see tips in our recent blog) and start saving up for a down payment. 

How much should you save? That all depends on your potential LTV — or loan-to-value — ratio. The amount you put down on a new home is important because it directly impacts your LTV and influences whether you'll even be approved for a mortgage. 

This article will unpack all you need to know about LTV and help you understand how it might affect your home-buying plans.

What is LTV?

First, let's get a quick definition out of the way. The LTV ratio is a percentage that illustrates the amount of a home loan when compared to the value of the home itself. In general terms, it shows how much of a property you'll own versus how much of it the bank will own.  

How is LTV used?

Lenders use the LTV to determine whether or not to loan you the cash needed to buy the home and to weigh how risky a loan is. 

• The higher the LTV, the riskier the loan. The riskier the loan, the higher the interest rate may be. 
• The higher the interest rate, the deeper you'll have to dig into your pockets to pay the monthly mortgage. 
• You can guess where this is going: the harder it is for you to come up with a larger monthly payment, the more likely you might default on the loan. 

Estimating your LTV

LTV is calculated by dividing the total loan amount by the appraised value of a home. And even though you may not know how much you'll want to borrow, this is a good exercise to determine ranges for house prices and down payments.

• For example, imagine you're thinking of buying a home that is valued at $200K. 
• Now imagine you're able to put down a 20% down payment, or $40K.
• $200K – $40K = $160K, the remaining amount you'd need to borrow.
• $160K (loan amount) divided by $200K (home value) = 0.80 or 80% (LTV).

In the above scenario, you'd own 20% of the home and the bank would hold 80%. As you make a payment each month, you chip away at the principal balance and own a little more, causing your LTV to drop. The LTV also falls if home prices rise in your neighborhood or you take on home improvements that increase your property's value. 

How loan-to-value ratios can affect you

As you can see, your LTV will be directly reduced by your down payment. Here's why that's important: with an LTV that's too high, a lender might consider you too big of a risk because if you default, they might not recover their losses by selling the property.  Lenders would rather see lower LTV ratios because it means you have more skin in the game and are less likely to default. 

If you are approved, a high LTV might cause you to end up with higher interest rates, even if you have a good credit score. That'll cause you to have higher monthly payments, which will add up over time and make a big difference in the total amount you'll end up paying back.

You may also be required to pay private mortgage insurance (PMI) if your LTV ratio is too high, and that will raise your monthly payments. Expect to pay at least 0.3% of the amount borrowed, annually. Sometimes much more.

Let's not forget those who are refinancing. If you're looking to refinance your mortgage, a lower LTV ratio will often get you more favorable terms. Homeowners who are refinancing may have already built up some equity, so the LTV ratio will inherently be lower than that of a new homeowner.

Can you lower your LTV?

Yes, there are ways to lower your loan-to-value ratio!

• Put more down: It should be evident by now, but if you want a more attractive LTV, consider setting your sights on a less expensive home or wait until you have saved a bigger down payment.
• Pay more each month: Once you own your home, try to pay a little extra toward the principal every so often. It not only lowers your LTV, but it also saves on interest payments over the long term.
• Consider different loans: As mentioned above, many loans allow for higher loan-to-value ratios. Here are three:
  • FHA Loans: With an FHA loan, you can make a down payment as low as 3.5%. That means an LTV ratio of 96.5% is acceptable (but again, you may need to buy PMI.
  • USDA Loans: This loan is backed by the U.S. Department of Agriculture. Since no down payment is required, your LTV ratio can be as high as 100%. However, to qualify for a USDA Loan, there are income property location requirements you must meet.
  • V.A. Loans: Like USDA loans, VA Loans are also government-backed (by Veteran Affairs), do not require a down payment and allow LTVs up to 100%. Of course, you'll need to be a current or former U.S. military personnel. 

Now you know!

If there are two things to take away from this blog post, it's this: 

1. The loan-to-value ratio weighs heavily in whether or not a lender decides to approve your mortgage. 
2. A lower LTV ratio means you have greater equity and will help you save money throughout the life of your loan. 

Have questions about LTV, PMI or any other part of the mortgage process? Reach out to one of our local loan officers. We're glad to help! Or, if you're ready to get started now, you can always apply online!