This is Why Your LTV Is Important When Applying for a Loan
You may not know all that much about a loan-to-value ratio, or an LTV ratio. This is a ratio that describes the size of the home loan that you have taken out in comparison to the property value that is securing the loan in place. Lenders make use of LTV’s in order to determine the risk factor of a loan. This translates into the fact that higher LTV ratios are suggestive of higher risks.
As there is less chance that the assets securing the loan can pay the loan off as the LTV ratio increases. This is why the LTV ratio is commonly used for the approval of home loans or even if you need mortgage insurance. In other words, the LTV describes how much of the property you actually own against how much you owe. This ratio is actually used for several kinds of loans, including mortgages and even car loans, both refinances and purchases.
How LTV is Calculated
In order to calculate an LTV ratio, you must divide the amount of the loan into the total asset value that is securing the loan. For example, if you have an interest in purchasing a house to the value of $200K, and you have $25K available as a deposit or down payment, you will have to then borrow $175K. This means your LTV will work out to be 87.5% or $175 divided by $200K.
Why LTV Matters
The LTV ratio is important because it is a simple way for lenders to evaluate the risk of a loan to you. The more they lend you, the more risk they undergo. A higher risk for the lender translates into it being more difficult to get approval for loans. It may mean you need to pay more with a higher interest rate. Not just that you might also end up paying mortgage insurance.
If you have to work out your LTV, the chances are that you’re dealing with a loan secured by collateral. This means that the lender gets some type of security in that if you default on your payments, they can recover their costs through reselling the property or the car. This is not because actually have an interest in your assets. But rather because they want their money and want to be sure they get it.
What A Good LTV Ratio Looks Like
A good LTV ratio is dependant on the specific lenders’ preference as well as on the type of loan at hand. However, your chances are significantly better with a low LTV ratio. When it comes to mortgages, 80 percent is the sweet spot. When you borrow more than 80% of the value of the home, you are normally required to get private mortgage insurance in order to protect your lender. It is an added expense, but it is often an option to cancel this insurance once you reach below 80% LTV.
Bad LTV Ratios
In the event that an LTV ratio is higher than 100%, it means that the loan you are taking is actually higher in value than what the asset is worth. This means you have negative equity, which is not a good thing. Typically, it turns out not being a good situation because you would need to write a check for the sale of the asset and this means you wouldn’t see any money out of the sale.
This is called an underwater loan. Underwater home loans became a huge issue during the mortgage crisis, and underwater car loans are always a problem. Should you decide to borrow with an LTV ratio above 100%, you really have to make sure your reasons are good!
So in the bigger scheme of things, the LTV ratio is a very important number. However, they work in conjunction with your credit score, your available income, and the asset that you are buying. Another important ratio is the debt to income ratio, but that’s for another article! Now that you know a little more about LTVs. You have a better chance of understanding what’s going on when you go about applying for mortgage loans or even car finances. It is important to gain a good understanding of every element of the contract you enter into!
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