How Does LTV Affect Mortgage Rate

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 6 minute read

As of the end of Q4 2021, the average price of a house had risen to almost $408,000. How comfortable are you making such a payment personally? It’s really unlikely. This is why most homebuyers seek out mortgage loans.

The mortgage approval procedure might take a lengthy time since lenders consider a wide range of criteria. When you refinance, you’ll go through a very identical procedure. A loan’s loan-to-value (LTV) ratio is one factor considered by lenders.

What Is a Loan-to-Value Ratio?

How much you’re borrowing in relation to the value of the collateral you’re using to secure the loan is known as the loan-to-value ratio. The mortgage loan sum is compared to the home’s current market value. The ratio between your vehicle loan debt and the car’s fair market value is calculated.

LTV is used by lenders as a gauge of the potential for loss on a loan. The lower the loan-to-value ratio, the lesser the risk to the lender. The likelihood of the lender recouping its losses in a foreclosure sale increases with a lower LTV ratio, which occurs when a borrower defaults on payments and the lender takes back the property. Lenders have a greater chance of financial loss with a higher LTV.

Maximum loan-to-value ratios (LTVs) may be set by individual lending institutions. As an example, the minimum LTV for an FHA loan is 96.5%. The maximum loan-to-value (LTV) for a conventional loan is 97%, and even then, that’s reserved for the most creditworthy customers; the industry standard is 95%. The LTV of your loan might also have significant effects on your interest rate and payment amount.

Obtaining the Loan-to-Value Ratio

Your loan’s interest rate is heavily dependent on the LTV, therefore figuring it out ahead of time is crucial.

LTV Calculator

The LTV ratio is found by dividing the loan debt by the appraised value of the property.
So, here’s the formula:

  • (Loan balance / Home value) = LTV

Example of LTV Calculation

Let’s pretend you’re interested in a house that has been valued at $300,000 and it’s currently on the market. A $270,000 mortgage is authorized for you when you apply for one. The LTV of that loan is:

  • $270,000 / $300,000 = 90%

Your mortgage’s LTV will be if you make a 20% down payment and borrow $240,000 total.

  • $240,000 / $300,000 = 80%

The loan-to-value ratio (LTV) gradually decreases from this starting point as principal is paid down and as market value of the house rises and falls. A mortgage’s loan-to-value (LTV) ratio typically decreases when its principal balance is reduced.

How LTV Influences Mortgage Rates

LTV is used by lenders as a gauge of the potential for loss on a loan. The risk associated with a loan increases as its LTV rises. Lenders mitigate risk in a variety of ways.. 

Their high interest rates on risky loans are one drawback. High loan-to-value (LTV) loans often have a higher interest rate than those for which a bigger down payment was required. Obviously, if your interest rate is larger, so will be your monthly payment and your total loan cost.

Borrowers applying for riskier loans may also be subject to higher interest rates. You could have to pay extra points or the lender might tack on a larger origination fee, for instance, to get the rate you want. An increase in the down payment might result in cheaper initial costs.

When calculating the loan-to-value (LTV) ratio of a mortgage, PMI is a major factor (PMI). Even while private mortgage insurance (PMI) does not affect your interest rate, it is still an extra expense. For loans with an LTV below 80%, private mortgage insurance (PMI) is often required by lenders.

The annual premium for PMI might be as much as 2% of the total loan amount. Especially if your mortgage is already somewhat hefty, that might be a significant additional expense.

LTV Ratio Guidelines for Various Mortgage Types

There is a wide variety of mortgage options available to suit the needs of a wide range of potential homeowners. The LTV standards and guidelines might vary from program to program.

Conventional Loan

One that is approved by Fannie Mae and Freddie Mac is considered a conventional mortgage. These loans are not guaranteed by the government, but they still have to fulfill the standards set by Fannie Mae and Freddie Mac. Most mortgage loans end up being repackaged and sold to investors after they close.

Loan-to-Value (LTV) limits for conventional mortgages top out at 97%. This means that you will require a down payment equivalent to at least three percent of the home’s price. If your loan-to-value ratio (LTV) is over 80% from the outset, private mortgage insurance (PMI) premiums will be required until your LTV falls to 78% or below.

Mortgage Refinancing

The process of mortgage refinancing allows you to exchange your current loan for a new one. Here’s your chance to make changes to your loan’s terms, such as the interest rate or term. Some lenders may be ready to make an exception and refinance loans with an LTV of more than 80%.

FHA Loans

FHA loans are well-liked by homebuyers due to the fact that they need only a 5% down payment and are available to borrowers with less-than-perfect credit.

The maximum LTV for an FHA loan is 96.5%, so you’ll need to put down at least 3.5% of the purchase price. If your loan-to-value ratio (LTV) is more than 90% at the outset of your mortgage, you will be required to pay private mortgage insurance (PMI). Your loan-to-value ratio must be below 80% for PMI to be dropped after 11 years.

VA Loans

The Department of Veterans Affairs backs loans made to veterans. Veterans, active-duty service members, members of the National Guard or Reserves, and certain surviving spouses are the only people who can get them.

There are several advantages to these loans, including the possibility of obtaining a loan with an LTV of 100%. That implies you can get a loan for the total amount of the house’s buying price. The only up-front expenses are the borrowing fees.

USDA Loans

The United States Department of Agriculture (USDA) offers guaranteed loans to qualified homebuyers in rural communities. There are also strict income caps that potential borrowers must not be able to afford to fall short of.

Loan-to-Value (LTV) ratios for USDA loans can reach 100%, allowing borrowers to finance the full purchase price of a property. Financing some of the loan’s up-front costs might increase the LTV above 100%.

Fannie Mae & Freddie Mac

The Federal Housing Administration (FHA) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are two such mortgage finance businesses. Loans are not something either company provides to customers directly. They do not make loans themselves, but rather act as guarantors for loans made by other institutions.

As a result, lenders compete to provide loans that satisfy the two businesses’ standards, as they together control a sizable chunk of the mortgage secondary market. Maximum loan-to-value ratios (LTVs) for single-family homes are 95% with Freddie Mac and 97% with Fannie Mae for fixed-rate loans and 95% with adjustable-rate mortgages (ARMs).

LTV’s Restrictions

Using LTV ratios in mortgage financing has a number of downsides for both the borrower and the lender. One drawback of LTV is that it focuses just on the mortgage, rather than all of the debts the borrower may have. The low loan-to-value (LTV) on a mortgage may make it appear as though the lender is taking on little to no risk. But even if the LTV is low, the borrower may have trouble making the payments if they have a lot of other loans.

The borrower’s income is ignored by LTV, despite its importance to the borrower’s capacity to repay the loan.

Accurate house value estimates are also essential for calculating LTV ratios. An appraisal is often requested by the homeowner or the lending institution. However, it might be challenging to ascertain the exact worth of a house if its value has increased over time without having another evaluation.

This means that you might be paying for PMI on a loan even when the LTV has been reduced because of appreciation in the value of your house. You can always get a second opinion, but you’ll have to pay for it yourself (usually around $500).

Bottom Line

The loan-to-value (LTV) ratio is one metric used by financial institutions to assess the safety of a loan request relative to the value of the collateral backing the loan. LTV is crucial in the real estate industry since it affects PMI and mortgage rates.

Reducing your loan-to-value ratio (LTV) is an important step if you wish to avoid or cancel private mortgage insurance (PMI). You may accomplish this by making modifications to your house that raise its worth, then having an expert appraise the property; alternatively, you can pay additional principal each month to bring down your mortgage debt more quickly.

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