What Is a Loan-to-Value Ratio and How Does It Impact a Mortgage?
A loan-to-value ratio is a calculation that measures how much of your home’s value you’re borrowing. Your LTV ratio may affect your interest rate, monthly payment and how much you can borrow.
What is a loan-to-value ratio?
A loan-to-value ratio is a measurement, expressed as a percentage, of how much your loan amount is compared to the value of a home, and it’s used by lenders to gauge a loan’s potential risk. In other words, the less you put down, the more likely it is that a lender will lose money if you default and they have to foreclose on your home.
You may hear your loan officer refer to “high-LTV” loans and “low-LTV” loans. A “high-LTV” loan means you’re borrowing more money compared to your home’s value, and the lender stands to lose more if you default. A “low-LTV” loan means you’re putting down more money upfront toward your home’s purchase price. Lenders take that as a good indicator that you’ll be able to repay your loan.
How to calculate your loan-to-value ratio
Calculating your LTV ratio is easy: You simply divide the amount you’re borrowing by the price or value of the property.
Purchase LTV ratios. The LTV ratio for a home purchase is calculated by dividing your loan amount by the home’s sale price. For example, if you’re buying a $200,000 house and making a 3% down payment, you’re borrowing $194,000. That means your LTV ratio is 97% (194,000 /200,000 = 0.97).
Refinance LTV ratios. To calculate the LTV ratio for a refinance, divide your current loan balance by the value of your home. If your loan balance is $240,000 and your home is worth $300,000, your LTV ratio is 80% (240,000/300,000 = 0.80).
What is a good loan-to-value ratio?
The standard benchmark for a “good” loan-to-value ratio is 80%, because it allows you to avoid paying private mortgage insurance (PMI). Mortgage insurance protects a lender if you default on your mortgage, and it’s required on most conventional mortgages with less than a 20% down payment.
Loans backed by the Federal Housing Administration (FHA) allow you to purchase a home with a score as low as 500 with a 90% LTV ratio, but you’d need at least a 580 score for a higher LTV ratio FHA loan. In addition, your FHA mortgage insurance will drop off after 11 years with a 10% down payment; lower down payments will require mortgage insurance for the life of the loan.
The U.S. Department of Veterans Affairs (VA) guarantees loans made to military borrowers with no down payment required. VA borrowers typically pay a one-time VA funding fee to defray the program cost to taxpayers. However, VA borrowers can save money on the funding fee if they put money down to lower their LTV ratio.
Maximum loan-to-value ratios for different types of mortgages
You’ll have more high-LTV ratio lending options if you’re buying a home, or refinancing to a lower rate (usually called a rate-and-term refinance). If you want to tap your home equity for home improvements or debt consolidation, lenders set a lower LTV ratio cap.
Here are LTV ratio limits for the most common purchase and refinance loan programs for single-family homes:
|Cash-out refinance||Not allowed|
The lender may limit you to a lower LTV ratio if:
- You’re buying or refinancing a rental property.
- You’re buying or refinancing a manufactured home.
- You’re buying or refinancing a two- to four-unit home.
- You’re buying or refinancing a second (vacation) home.
You may be able to borrow more than the limits above if:
- You’re taking out a home equity loan or home equity line of credit (HELOC).
- Your home is worth less than your mortgage balance and you’re eligible for a Home Affordable Refinance Program replacement loan.
- You’re applying for Fannie Mae’s Community Second program that allows you to borrow up to 5% more than your home is worth. Income limits and neighborhood restrictions apply.
Tip: Explore mortgages that don’t require a loan-to-value ratio
If you currently have an FHA or VA loan, there are refinance options that don’t require an LTV ratio. The FHA streamline refinance and the VA interest rate reduction refinance loan (IRRRL) don’t require a home appraisal, which means no LTV ratio is calculated. You also won’t need to verify your income for either program.
Why does your loan-to-value ratio matter?
Your loan-to-value ratio is important because it affects your monthly payment, down payment amount and closing costs.
The table below shows the differences between a 95% LTV ratio and an 80% LTV ratio on a 30-year, fixed-rate conventional purchase loan for a $250,000 home. It also assumes closing costs are 2% of the loan amount and the interest rate is 3.75%.
|LTV ratio||Loan amount||Down payment||Monthly payment*||Closing costs|
*Assumes $3,125 annual property taxes, $875 annual homeowners insurance, $123.70 per month mortgage insurance and $50 monthly HOA fees
**Assumes $3,125 annual property taxes, $875 annual homeowners insurance and $50 monthly HOA fees
With a high-LTV ratio loan:
- You’ll have a lower down payment, which leaves more cash in the bank.
- You’ll have a higher monthly mortgage payment.
- You may have a harder time qualifying for a loan because of the higher payment.
- Your closing costs are higher due to a higher loan amount.
- You may end up losing money if you need to sell sooner than expected.
- You may need to pay monthly mortgage insurance premiums.
When it comes to a low-LTV ratio:
- You’ll have a higher down payment, leaving you with less cash in the bank.
- You’ll pocket more money when you sell because you’ll have more upfront equity.
- You may get a lower interest rate.
- You’ll avoid paying mortgage insurance with 20% down.
- You’ll have more home equity to tap if you need it in the future.
- Your closing costs may be lower because you’re borrowing less.
Does your loan-to-value ratio affect your interest rate?
Typically, the higher your loan-to-value ratio, the higher your interest rate. This is especially true on a conventional mortgage if you need PMI and have low credit scores. Another drawback: You’ll pay a higher PMI premium for a higher LTV ratio if you also have a poor credit history.
How to lower your loan-to-value ratio
Try one of these steps to knock your LTV ratio down and boost your home equity.
- Get a gift for a bigger down payment. A family member, employer or friend can contribute a gift to use toward your down payment amount and closing costs.
- Make extra principal payments. Your LTV ratio drops with every mortgage payment. If you make even one extra payment each year, you’ll lower the LTV ratio faster.
- Pick a shorter-term loan. If your budget can handle a higher monthly payment, a 15-year fixed mortgage will lower your LTV ratio more quickly than a 30-year loan.
- Buy a less expensive home. Choosing a home at the lower end of your down payment budget can help you avoid a high-LTV ratio loan.