Loan-to-Value Ratio: What is LTV?

Loan-to-value ratio, or LTV, measures the balance of an outstanding loan against the value of the asset that the loan purchased. This figure is calculated by dividing the loan's balance by the asset's value. A higher LTV ratio means that less of the loan has been paid off. As such, LTV should decrease over time as loan repayments are made. LTV is most commonly used to measure the value of mortgages and auto loans.

Loan-to-Value (LTV) Explained

Loan-to-value ratio is a simple way for lenders to determine the relative size of a loan. LTV is calculated as a percentage out of 100, with higher LTVs signifying that more of the asset is financed with a loan. To calculate LTV, divide the value of the loan by the price of the asset being purchased with a loan. For example, a borrower who uses a $97,000 loan to purchase a $100,000 home would have an LTV of 97%.

  • Loan Amount ÷ Asset Purchase Price = Loan-to-Value (LTV) Ratio
  • If Loan Amount = $97,000 and Home Purchase Price = $100,000…
  • Then $97,000 ÷ $100,000 = 97% LTV

LTV is often used to measure how much risk a lender takes when making a loan. Loans with higher LTVs are riskier because the borrower has put down less of their own money towards the purchase and theoretically has a higher chance of defaulting. As such, loans with higher LTVs generally come with higher interest rates.

Most commonly, LTV is used to express the size of a mortgage before it is made. For example, lenders of conventional mortgages will make home loans up to a 97% LTV—meaning that they'll finance 97% of the value of the home being purchased. The remainder of the home's purchase price must be financed by the buyer in the form of a down payment. In this case, a 97% LTV would mean that homebuyer must make a down payment that is 3% of the home's purchase price.

LTV for Mortgages

Over time, mortgage borrowers increase their share of ownership in their home by making payments each month. As these payments go towards decreasing the mortgage's outstanding balance and increasing equity, the borrower's LTV will also decrease.

In general, making a bigger down payment in exchange for a lower LTV will save money in the long run. Borrowers with less equity in their homes are seen as bigger risks, meaning that they'll pay higher interest rates and insurance costs. For example, borrowers who make down payments greater than 20% of their home's value don't have to pay mortgage insurance. However, for those who can't afford a larger down payment, refinancing into a cheaper mortgage at a later time is a good option.

LTV and Mortgage Refinancing

Once the LTV is low enough, borrowers can often qualify for better mortgage rates through a refinance. For example, conventional mortgage borrowers with LTVs under 80% do not have to pay for mortgage insurance, as the risk of defaulting is lower. As such, many homeowners with FHA mortgages refinance into conventional mortgages once their LTV drops below 80%—because FHA loans allow for low down payments but require insurance for the life of the loan.

On the other hand, struggling homeowners with LTVs above 80% can also qualify for refinancing programs. Specifically, the government-run Home Affordable Refinance Program (HARP) targets homeowners who have made their mortgage payments on time, but who have a high LTV due to declining home prices or some other factor.

Takeaways

  • Higher LTVs are seen by lenders as a larger risk
  • Lower down payments lead to lower LTVs and higher interest rates and mortgage insurance expenses
  • Home appreciation can decrease loan-to-value ratio, while declining prices can increase it

LTV for Auto Loans

Auto lenders also use LTV to assess the risk of making a loan. Similar to mortgages, a higher LTV means that a loan is riskier. However, LTV works a little differently for auto loans—cars lose value over time, while most houses increase in value. This means that a higher LTV is particularly risky for an auto loan borrower, as car depreciation can quickly cause the car's value to drop below the loan's outstanding balance. This phenomenon is known as being "upside-down," and it should be avoided at all costs.

To avoid having an LTV rise above 100%, it's important to take on a car loan within your means. It's advisable to pick a car, either new or used, that can be paid off within 48 months, and for which you can make a 20% down payment. While longer term options of 72 or 84 months can help you afford more car, they also put you at risk of becoming upside-down. This is dangerous because it means that selling your car won't cover the cost of the loan's outstanding balance—if this happens and you're in financial distress, you might need to take out a personal loan to cover outstanding auto debt.

Takeaways

  • Cars depreciate quickly and auto loans with high LTVs should be avoided
  • Bigger down payments for cars are necessary—shoot for over 20%

Combined Loan-to-Value (CLTV) Explained

Combined loan-to-value ratio, or CLTV, measures the balance of all outstanding loans on an asset against the value of the asset. To calculate CLTV, the total dollar amount of outstanding loan are divided by the asset's assessed value.

  • All Loan Amounts ÷ Asset Value = Combined Loan-to-Value (CLTV) Ratio
  • If Loan Amount 1 = $35,000, Loan Amount 2 = $60,000 and Home Value = $100,000…
  • Then ($35,000 + $60,000) ÷ $100,000 = 95% LTV

CLTV is commonly used to measure the risk of lending a second mortgage to someone. For example, many homeowners draw home equity lines of credit (HELOCs) to access the equity they've built in their homes. However, homeowners with high CLTVs who've built little equity in their homes might not qualify for a second mortgage. As lending restrictions have become more stringent in recent years, most lenders now require borrowers to have initial LTVs of 80% before qualifying for a second mortgage.

How to Calculate Loan-to-Value Ratio

While the mathematical calculation for LTV is relatively straightforward—loan balance divided by asset value—it may be a bit more difficult to find out how much your car or house is actually worth. One way to figure this out is to get a certified appraiser to evaluate how much your asset would sell for in the current market. If you're in the process of taking out a mortgage or auto loan, an appraisal will actually be required by your lenders.

For those who already own their home or car, an appraisal might be an unnecessary expense. If you're looking to find the value of your asset to get a rough idea of your LTV, there are easier and less expensive ways to do so. For example, you can find the current value of your home by multiplying its purchase price by the percentage that home values have risen in your area. This data is readily available on many real estate websites. For your car, you can find its current market value through one of the many online auto marketplaces and appraisal services.

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