A borrower’s loan-to-value ratio is one of the factors that is considered by lenders when deciding whether to approve a loan application. This figure is also used to determine whether the borrower will be required to pay for private mortgage insurance. In most cases, borrowers need to have a loan-to-value ratio of 80% or less.
High LTV ratios are generally associated with higher-risk loans, which can drive the interest rate up and cause an applicant to be rejected. If a borrower requests a loan for an amount that is close to or equal to the appraised value of the home, resulting in a very high LTV ratio, a lender will consider them to have a higher chance of going into default on their loan due to the lack of equity built up in the property. This means that if the lender has to foreclose on the property, they may struggle to sell the home for enough money to cover its outstanding balance on the mortgage and obtain a profit.
Here is a look at how this important ratio is calculated and its significance.
A Simple Formula
It follows a basic formula that entails dividing the current loan balance by the home’s current appraised value.
To make this calculation, a borrower needs to know the current loan balance on their home. This number is indicated on your monthly loan statement; you should also be able to locate it in your online account. You will also need a current home appraisal.
For an individual who has a loan balance of $200,000 on a home that appraises for $300,000, the equation is as follows:
$200,000 / $300,000 = .66
When converted to a percentage this becomes 66%, giving this individual a loan-to-value ratio of 66%.
Calculating The Combined Loan To Value Ratio For Multiple Loans
In some cases, a combined loan to value ratio must be determined. For example, for an individual who wants to obtain a home equity line of credit, it will be necessary to add the amount they intend to borrow or the credit limit they plan to establish to their current mortgage balance.
In the example above, the individual had a current loan balance of $200,000. If, for instance, they are seeking a $25,000 home equity line of credit, this means their combined loan balance will be $225,000. This figure can be used in the above formula to determine the combined loan to value ratio.
$225,000 / $300,000 = 0.75, or 75%
Most lenders are looking for a combined loan to value ratio of 85% or less in borrowers seeking a home equity line of credit.
What Happens If Your LTV Is Too High?
For those whose LTV is too high, waiting until the value of the home increases or paying down their current loan can help improve the ratio. Paying down the home loan’s principal can make a big difference. This occurs naturally over time by making monthly payments, as long as the loan is amortized.
It may be possible to reduce the loan principal faster by paying slightly more than the amortized mortgage payment every month. However, those who are interested in doing this should check with their lender to ensure they will not be charged prepayment penalties.
It is important to keep in mind that an LTV ratio is just one of several factors that is used to determine a borrower's eligibility for a home equity loan, mortgage or line of credit.
A higher LTV ratio will not automatically exclude a borrower from being approved. However, they may have to pay a higher interest rate to account for the greater risk. For example, a borrower whose LTV ratio is 95% may be given an interest rate that is a full percentage point higher than that offered to a borrower whose LTV ratio is at or below the standard threshold.
Borrowers whose LTV ratio exceeds the threshold may be required to buy private mortgage insurance. This may add as much as 1% to the total amount of the loan on a yearly basis and must be paid until the LTV ratio reaches 80% or lower.
Although 80% is a nearly universal LTV ratio requirement for borrowers who want to avoid the expense of private mortgage insurance, exceptions are sometimes made for borrowers who have very low debt, a significant investment portfolio or a high income.
Discuss Your Borrowing Needs With Woodsboro Bank
Woodsboro Bank is committed to their customers, and to the communities they work with. Whether you are looking for a home equity loan, line of credit or second mortgage, the team at Woodsboro Bank can help you determine your loan-to-value ratio and find a custom solution to your borrowing needs. Contact us today to learn more about our services.