What is LTV When Taking a Loan?

money lending

According to an article published in the Nerd Wallet, the average US household with debt carries $15,675 in credit card debt and $132,158 in total debt. This projects a picture of finance that often goes unnoticed.

If you look specifically at student loans, Americans owed about $1.3 trillion in student loan debt spread across 44 million borrowers. The debt taken in 2016 for education increased by 6 percent from the previous year.

The fact that people are unable to repay their loans is a worrying one, and this is because they tend to borrow more than their ability to repay.

What is LTV?

The loan-to-value or LTV ratio is a lending risk management ratio that financial institutions and other lenders examine before approving a mortgage. If your LTV ratio is on the higher side, then the risk involved in sanctioning the money to you is also considered to be higher.

In such cases, the loan costs the borrower more than it otherwise would, and they also may have to purchase mortgage insurance in order to offset the risk to the lender.

How is the LTV Calculated?

The LTV ratio is calculated as the amount of the mortgage lien divided by the appraised value of the property and is expressed as a percentage. For example, if a borrower wants $85,000 to purchase real estate worth $100,000, then the LTV ratio comes out to be 85%.

It is an important aspect of lending money for when you are looking to buy new property, refinance a current mortgage into a new loan or borrow against an existing property.

All the lenders use the LTV as a tool to identify the risk they are being exposed to.

Implications of High LTV

What has to be understood here is that the LTV is not the only factor used to determine the loan amount, and despite having a high LTV, borrowers can get the desired amount. However, such cases are few and far between.

Most lenders prefer to offer loans at the lowest interest rate only when the LTV ratio is at or below 80 percent. Borrowers with a higher LTV have to pay a higher interest. It also has the potential to raise the borrower’s monthly mortgage payment.

This happens because lenders perceive that there is less to no liquidity built up within the property and in case of a foreclosure, they may find it difficult to sell it.