Loan to value (LTV) ratio is a term frequently used in relation to mortgages. It is a ratio that involves the loan amount and the value of the property for which someone has applied for a mortgage. This ratio is calculated by dividing the mortgage amount by the amount for which the property has been appraised.
Loan to value ratios are typically expressed as percentages. For example, if a person wants to borrow $75,000 US Dollars (USD) for a property with an appraised value of $85,000 USD, the loan to value ratio is 88.23 percent. Likewise, if a person needs to borrow $50,000 USD to purchase a property that has an appraised value of $75,000 USD, the loan to value ratio would be about 66 percent.
When lenders consider loaning mortgage money, they typically consider the loan to value ratio in making their decisions; a lower home to value ratio is considered optimal. This is because higher loan to value ratios translate into more risk for the lending company. In such a situation, the borrower is financing more of the property, and the lender stands to lose more if the borrower defaults on the loan. For example, if the lender forecloses on a property with a higher loan to value ratio, the lending company must hope to auction the property and sell it for a higher amount in order to recoup the money it lent. On the other hand, if it only lent 40 percent of the appraised value of the property, it will have a much easier task at hand and a better chance of recouping its money.
Despite the fact that making higher loan to value loans is risky, some lenders will provide 100-percent loan to value loans. These types of loans are often offered to those with good credit. Lenders feel more comfortable offering these loans to borrowers with good credit because they have shown responsibility with paying bills in the past, which translates into lower overall risk for the lenders. As such, a lender may decide that such an attractive potential borrower is worthy of some extra risk.
The LTV is important not only in property purchase situations but also in the case of mortgage refinance loans. Essentially, the loan to vale ratio in a refinance situation compares the amount a person needs to borrow with the amount of equity he has in his home or property. Equity is the difference between the home’s worth and the amount the borrower still owes on his mortgage.
