Loan-to-value (LTV) is an equation used by mortgage lenders to assess their risk when lending money to a borrower to purchase a property. The ratio between the amount of money borrowed and the value or purchase price of the property is used to determine the LTV. The purpose of establishing LTV is to protect the lender from lending more money than the property is worth. The lower the LTV, the lower the interest rate a borrower will receive. Private mortgage insurance is required for LTV rates greater than 80%. A property’s LTV ratio also determines the amount a lender will give to a borrower who wants a home equity line of credit or second mortgage.
The term loan-to-value, or LTV, is primarily applied to the mortgage banking industry. It is an equation that mortgage lenders use to assess their risk when lending money to a borrower to purchase a property. The equation is basically a relationship between the amount of money borrowed and the value or purchase price of the property, whichever is less. To determine the LTV of a new purchase, the purchase price or appraised value is divided by the down payment. As an example, if you were to buy a house for $100,000 United States Dollars (USD) and you were to apply $10,000 USD as a down payment, the loan to value ratio would be 90%.
The purpose of establishing loan-to-value when buying a home is to protect the lender from lending more money than the property is worth. That is why the appraised value must be at least equal to the purchase price. For consumers, the ratio weighs heavily on the interest rate you’ll receive on loan repayment. The lower the LTV, the lower the interest rate you will be given. In general, for every 5% increase in loan value above 70%, the interest rate increases by 1/8 percent.
Additionally, most lenders require private mortgage insurance, or PMI, premiums at rates greater than 80%. The premium for private mortgage insurance will depend on the insurance company and lender, but can be up to 1% of the loan amount.
Although the borrower will pay a higher interest rate at a 100% loan-to-value ratio, many lenders will offer this level of loan on a new purchase. However, a refinancing loan will generally not go 100%. Lenders determine the proportion of a refinance by requiring an appraisal of the property. They can usually check the sales prices of comparable properties within 1 mile (1.6 km) to determine the home’s value, but in special circumstances, a thorough appraisal may be necessary.
A property’s loan-to-value ratio also determines the amount a lender will give to a borrower who wants a home equity line of credit or second mortgage. The difference between the home’s value and the amount owed on the primary mortgage is the maximum amount that can be borrowed.
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