All about LTV! 5 ways to improve your loan-to-value ratio
LTV stands for the "loan-to-value" ratio. It's just a fancy way of saying how much money you're borrowing compared to how much the house you're interested in buying is worth.
Knowing your LTV is super important because it helps the lender determine how risky it is to give you a loan. The higher the LTV, the higher the risk to the lender — you'll have less equity in the property, and they have more to lose in the event you default on your loan.
But if you have a lower LTV, less money to put down, a lower credit score or a higher debt-to-income ratio, you may pay higher home loan interest rates, higher mortgage fees and possibly more mortgage insurance.
This blog will cover how to calculate your "loan-to-value" ratio and what you can do to improve it to your advantage.
Crunching your LTV numbers
To calculate the LTV of a mortgage, you need to divide the "L" or Loan Amount by the "V" or Property Value. The result is most commonly expressed as a percentage. Here's the formula:
LTV = (Loan Amount / Property Value) x 100
So, let's say you're buying a home valued at $400,000 and putting down a down payment of $40,000. That means you'll need a mortgage loan amount of $360,000.
LTV = ($360,000/$400,000) x 100
LTV = (0.90) x 100
LTV = 90%
When you calculate LTV, remember that the property value can either be the purchase price or the appraised value — an estimate determined by a pro.
5 ways you can improve your LTV
Improving your loan-to-value ratio might get you a better interest rate, more favorable loan terms, or a larger loan at a lower down payment. All of these things can save you money over the life of the loan. Here are six ways to improve your LTV:
1 - Save up more for the down payment
One way to improve your LTV is to increase your down payment. A larger down payment means you're taking on a smaller loan compared to the property's value. And if you can’t save up any more bank, remember, you can tap into “gift funds” for your down payment. That’s when a family member, employer or friend gives you some money (with no expectation of repayment) toward your down payment.
So let’s revisit our previous example, but double the down payment to $80K, so you’re only looking for a $320K loan.
LTV = ($320,000/$400,000) x 100
LTV = (0.80) x 100
LTV = 80%
An 80% loan-to-value ratio is much less risky for a lender and may get you a better interest rate.
2 - Buy a less expensive home
Buying a less expensive home (but using the same down payment) can really affect your LTV. Since the purchase price will be lower, the loan amount will also be lower as long as you use the same down payment amount. Let’s just say we skipped on that $400,000 house and found one for $300,000 that we liked just as much. We still had $40,000 to put down, so we’d need a loan of $260,000.
Back to our example:
LTV = ($260,000/$300,000) x 100
LTV = (0.86) x 100
LTV = 86%
Bonus! If the LTV ratio is lower, you may qualify for better loan terms, such as a lower interest rate or less restrictive loan requirements.
3 - Consider a shorter loan term
Can your budget handle a bigger monthly payment? If so, consider a 15-year fixed mortgage rather than a 30-year loan. Choosing a shorter loan term can reduce the overall interest paid over the life of the loan. As a result, the lender may require less initial equity from you and be willing to accept a higher LTV because they know your LTV will drop faster as you pay off the loan.
4 - Ask about other loan types
Even lender has different loan products - and different LTV thresholds. But several loan types generally allow for a higher LTV. These include:
- FHA loans are available to borrowers with lower credit scores and an acceptable initial LTV is 96.5%.
- VA loans are guaranteed by the Department of Veterans Affairs and are available to eligible veterans and active-duty military personnel. And since there’s no down payment necessary on these loans, the LTV can be as high as 100%
- USDA loans are backed by the U.S. Department of Agriculture. And like VA loans, no down payment is required, so your loan-to-value ratio can be 100%.
- Conventional loans are not insured or guaranteed by the government. They typically require a higher credit score and a lower LTV ratio, around 80%.
- Jumbo loans are for higher-priced homes and typically require a significantly lower LTV ratio, usually around 70%.
5 - Pay down the principal
If you buy your home despite having a high LTV, try to make one or two extra principal payments every year. Note that your additional payments don't have to include interest — just put money toward the principal. Paying it down can significantly reduce how much interest you'll pay over the life of the loan and can take a nice dent out of your LTV — while also upping your home equity. That will also come in handy if you look to refinance in the future.
And bonus: if your loan allows you to drop the mortgage insurance once you hit an 80% LTV ratio ± or 20% equity — those extra principal payments will help you reduce future monthly mortgage expenses even faster.
Have questions about LTV?
Remember that your loan-to-value ratio carries a lot of weight in convincing a lender to move forward with your mortgage. Having more skin in the game — more equity, per se — by achieving a lower LTV ratio will make you a lower risk and a more attractive borrower.
It's worth noting that LTV is just one factor that lenders consider when evaluating a home loan application. Other factors may include the borrower's credit score, debt-to-income ratio, employment history and the property's location and condition.
If you have questions about your loan-to-value ratio or any other part of the mortgage process, please feel free to reach out to one of our local loan officers.
Or, if you're ready to start now, you can always apply online!
