Loan to Value Calculation: LTV Ratio Formula

A loan to value calculation is one of the financial formulas that one would probably hear a lot about in a scenario of home loans. The LTV (loan to value ratio) is important because it may affect your borrowing power. This ratio is a measure of how lenders describe the amount you need to borrow to buy a certain property. In layman’s terms, the loan-to-value ratio is best described as the amount you need to borrow, calculated as a percentage of the property’s ‘lender-assessed value’ (i.e the lender’s valuation of the property).

Loan to value (LTV or LVR) is a commonly used ratio in mortgage lending. It determines the amount needed for a down payment and can also determine if a lender will extend credit to a borrower. When the loan to value ratio is at or below 80%, most lenders offer mortgage and home-equity applicants the lowest possible interest rate.

A loan-to-value ratio will show you how much of the property you truly own compared to the amount you owe on the loan you took out to purchase the property. Lenders usually use loan-to-value to determine how risky a loan is and whether they’ll approve, or deny the loan application and whether mortgage insurance will be required.

There are slightly different requirements for every lender that must be approved before they will issue you a mortgage. Mortgage insurance is usually required if your loan-to-value ratio is high. This kind of insurance is called Private Mortgage Insurance (PMI) which is required in order to offset the risk of the lender. Some lenders won’t issue mortgages to individuals who can’t meet a maximum LVR, while other lenders may alter their loan terms to accommodate the added risk by increasing the interest rate or requiring the borrower to purchase a PMI.

A PMI will help protect the lender from the borrower’s possible default. This private mortgage insurance policy helps protect the lender so that if the borrower can’t make his or her payments and goes bankrupt, the insurance company will pay the lender according to the terms of the policy. This mortgage insurance is usually a great alternative for individuals who don’t have enough money for the proper down payment. So, it allows them to qualify for a loan by making a small monthly insurance payment with their mortgage payment.

However, a lender will usually require a loan-to-value ratio of 80% or less to avoid you having to pay this PMI. From the lender’s perspective, a lower loan-to-value ratio generally carries less risk. This is because if your LVR ratio is lower, you will have more equity in your property right from the start. Equity is the market value of your property, minus the amount of the loan you still have to repay. Hence, a loan to value ratio is a type of market value ratio.

A critical component of mortgage underwriting is determining an LTV ratio. This ratio may be used in the process of refinancing a current mortgage into a new loan, buying a home, or borrowing against accumulated equity within a property. In order to determine the level of exposure to risk, lenders would usually assess the LTV ratio when underwriting a mortgage.

A lender perceives that there is a higher chance of a loan going into default if the borrower requests a loan for an amount that is at or near the appraised value of the property. Hence, there is a higher LTV ratio in such a case. This is because there is very little equity built up within the property. Therefore, in the event of a foreclosure, the lender may find it difficult to sell the home for a reasonable amount that will cover the outstanding mortgage balance and still have some profit from the transaction.

This means the more money a lender gives a borrower, the higher the borrower’s LTV ratio and the more risk the lender is taking. The fact is lenders don’t really want to take the property, so they just want some reassurance that they will still get their money back if you default. At least if they lend only up to 80% of the property’s value they can sell the property at less than top dollar to recover their funds.

A borrower is more likely to value his property and keep making payments when he has put more of his own money into the purchase. But once the loan is larger than the value of the asset securing the loan, the LTV ratio is usually higher than 100%. This means there is negative equity in such a case and the lender has to pay something to sell the asset and won’t get any money out of the deal. These kinds of loans are usually called underwater loans.

Therefore, the main factors that impact LTV ratios are:

1. The amount of the down payment
2. Sales price
3. The appraised value of a property

Hence, the lowest LTV ratio is achieved with a higher down payment and a lower sales price.

A borrower can use his home’s value and effectively increases his LTV ratio when he takes out a home equity loan. His LTV will decrease if his home gains value because the prices of housing rise, although he might need an appraisal to prove it. Moreso, one can use the land they are building on as equity for a construction loan if they are borrowing money to build a new house.

Loan to value ratio for refinancing

The typical loan to value ratio for refinancing that is considered ideal is 80% or less, though one can refinance with a higher ratio. When the loan-to-value ratio is at or below 80%, the majority of lenders offer mortgage and home-equity applicants the lowest possible interest rate.

Nevertheless, a higher LTV ratio does not stop borrowers from being approved for a mortgage, although there may be an increase in the interest as the LTV ratio increases. For instance, a borrower with a loan to value rate ratio of 95% may be approved for a mortgage, though, their interest rate may be a full percentage point higher than the interest rate given to a borrower with a loan to value ratio of 75%.

In cases where the loan to value ratio is higher than 80%, the borrower may need to purchase a PMI which can add anywhere from 0.5%-1% to the total amount of the loan on an annual basis. This PMI is usually required until the loan to value ratio is 80% or lower. As you pay down your loan and the value of your property increases over time, the loan to value ratio will decrease.

Generally, the lower the loan-to-value ratio, the higher the chance that the loan will be approved and the lower the interest rate is likely to be. With a lower LTV ratio, it is less likely for the borrower to purchase private mortgage insurance (PMI). Lenders require an 80% LTV ratio or lesser in order for borrowers to avoid the additional cost of PMI. This is not a law but it has become a practice of nearly all lenders. However, there are exceptions to this requirement sometimes for borrowers that have a high income, lower debt, or a large investment portfolio.

Loan to value calculation

The Loan to Value Ratio (LVR) calculation is done by dividing the loan amount by the lender-assessed value of the property. Generally speaking, after the loan to value calculation, most lenders consider an LVR of more than 80% as being risky. This is why if the LTV ratio is higher than 80%, the borrower may need to pay for PMI.

How to calculate loan to value ratio (LTV ratio)

The loan to value ratio formula is expressed as:

LTV ratio= MA÷APV

Where;

MA= Mortgage Amount

APV= Appraised Property Value

The LTV ratio is calculated by dividing the loan amount borrowed by the appraised value of the property, which is expressed as a percentage.

The LTV ratio formula can be applied to any type of loan, but it is most commonly used in the mortgage industry. During the mortgage application process, banks, underwriters, and other financial institutions make use of this loan to value calculation to determine what amount of down payment is required for the purchase of a loan. Hence, they are calculating the collateral needed to secure a loan.

The appraised property value in the denominator of the equation is almost always equal to the selling price of the property, though most mortgage companies will require the borrower to hire a professional appraiser to value the property. This is reasonable because the agreed-upon sales price doesn’t necessarily reflect the true market value of the property. So, the bank or lender wants to ensure the loan is properly collateralized.

For example, the bank won’t want to issue a $500,000 mortgage for a house that is only worth $425,000 because the purchaser is willing to buy the house for more than it’s worth. This doesn’t mean the bank will make a poor investment decision.

Examples of Loan to Value (LTV) ratio calculation

Here are some examples of how to find a loan to value ratio:

Example 1

Supposing Mr. A buys a home that appraises for $200,000 but the owner wants to sell it for $190,000. If Mr. A makes a down payment of $50,000, his loan is for $140,000. This results in an LTV ratio of 70%.

That is:

Loan amount ÷ Appraised value of property

= $140,000/$200,000

=0.7 × 100

= 70% LTV ratio

Now, if Mr. A increases the amount of his down payment to $75,000, his mortgage loan is now $115,00. This would make his LTV ratio 57.5% (i.e 115,000/200,000)

Example 2

Loan to value calculation is another way of expressing how much someone still owes on their current mortgage.

The loan-to-value ratio formula will be:

Current loan balance ÷ Current appraised value

For instance, a woman currently has a loan balance of $140,000 (she can find her loan balance on her monthly loan statement or online account). Let us say her home currently appraises at $200,000. Her loan-to-value equation would be calculated like this:

$140,000 ÷ $200,000 = 0.70

Converting 0.70 to a percentage will give us a loan-to-value ratio of 70%.

This is a typical example of how to calculate loan to value ratio for a mortgage. Hence, the loan-to-value ratio on a mortgage is defined as the measure comparing the amount of the mortgage with the appraised value of the property.

Example 3

Let’s say you want to start a business and want to purchase a building with a market value of $1 million. This market value amount may be determined by a certified appraiser, or by the two parties who agree to carry out the sale of the building. Now, if you invest $200,000 in the project and apply for a loan of $800,000, the LTV ratio is 80%.

That is:

Secured loan amount ÷ Market value of collateral

= $800,000/$100,000

=0.8 × 100

= 80% LTV ratio

Example 4

Miss Sophia just graduated college and got her first job. So, she is looking to purchase a house which is valued at $250,000 near her new workplace. However, Sophia’s bank requires an 80% loan-to-value ratio. The bank would use a loan-to-value calculator to calculate the minimum required down payment amount that Sophia has to make.

Let’s calculate this:

LTV Ratio= Mortgage amount ÷ Appraised value of property

i.e 80% (0.8)= Mortgage amount ÷ $250,000

Mortgage amount= 0.8 × $250,000

=$200,000

As you can see from the calculation, the maximum mortgage that the bank will issue Sophia for this house purchase is $200,000. Hence, Sophia has to make a down payment of $50,000 in order to get approved for the loan.

Example 5

Supposing Amanda buys a home appraised at $100,000 for its appraised value, and makes a $10,000 down payment, she will have to borrow $90,000. This results in an LTV ratio of 90%.

Calculating loan to value ratio of this would be:

Loan amount ÷ Appraised value of property

= $90,000/$100,000

=0.9 × 100

= 90% LTV ratio

Example 6

When dealing with more than one loan, a combined loan-to-value ratio (CLTV) can be calculated. For someone considering a home equity line of credit, the person would have to add the amount he/she wants to borrow or the credit limit he/she wants to establish to his/her current mortgage balance. This would give the person the combined loan balance.

The combined loan-to-value formula would look like this:

Current combined loan balance ÷ Current appraised value = CLTV

For instance, Mr. X currently has a loan balance of $140,000 (which he can see on his monthly loan statement or online account). Mr. X wants to take out a $25,000 home equity line of credit and his home currently appraises for $200,000. Hence, his combined loan to value calculation would look like this:

$165,000 ÷ $200,000 = 0.825

Convert 0.825 to a percentage, and that gives us a combined loan to value ratio calculation of 82.5%.

For a home equity line of credit, most lenders would require the CLTV to be 85% or less. However, if one’s CLTV is too high, the person can either pay down their current loan amount or wait to see if their home’s value increases.

Acceptable LTV Ratios

There are really no limitations on LTV Ratios. This ratio is an implication rather than an exact science. There are no rules that will tell you that a loan will be granted if your LTV ratio hits a certain percentage. However, your odds of loan approval increase if the LTV ratio is near an acceptable percentage.

The majority of time, an LTV ratio that is close to 80% is usually the accepted ratio when it comes to home loans. But with a loan-to-value ratio of more than 80%, you’ll generally have to get private mortgage insurance (PMI) to protect your lender. This is an extra expense, but the insurance is usually canceled once you get below 80% LTV. Another notable LTV ratio is 97%. Some lenders would allow the borrower to buy with this ratio, but they’ll pay mortgage insurance, possibly for the life of the loan.

When it comes to auto loans, LTV ratios often go higher, but lenders can set limits or maximums and change the rates depending on how high the LTV ratio will be. In some cases, the borrower can even borrow at more than 100% LTV, because compared to other types of assets, the value of cars can decline more sharply.

Drawbacks of using the LTV ratio formula

The disadvantage of the information that an LTV ratio gives is that it only includes the primary mortgage that a borrower owes, and does not include in its calculations other obligations of the borrower, e.g. a second mortgage or home equity loan. Hence, the combined loan to value (CLTV) ratio is a more inclusive measure of a borrower’s ability to repay a loan.

Key takeaways

• A loan to value (LTV) ratio is best described as the percentage of a property’s value that is dedicated to a loan.
• The LTV ratio is one factor used in determining eligibility for securing a home equity loan, a line of credit, or a mortgage.
• The acceptable LTV ratios can vary, depending on the type of loan. For instance, auto loans can be approved with higher ratios than home loans.
• The LTV ratio formula is LTV ratio= MA÷APV. Where MA is the Mortgage Amount and APV is the Appraised Property Value.
• If your LVR on a mortgage loan is more than 80%, you will most likely be required to pay for private mortgage insurance.
• Loan approval can depend on a combination of factors, which could include your credit history, loan-to-value ratio, and your debt-to-income ratio.

FAQs on loan to value calculation