What Loan to Value Ratio Means for Home Equity Loans

A home equity loan sometimes called a second mortgage, allows you to tap into the equity of your home. This gives you access to cash liquidity, and the flexibility to take on large expenses, like home renovations, make a large purchase, consolidate other debts, or create a safety net during a family transition, like a layoff or taking time off for childcare. 

It’s important to understand how your bank will assess your home equity loan application so you can get the most competitive interest rates and most favorable loan options. One of the ways your application is assessed is via your LTV, which stands for loan-to-value ratio. 

To calculate loan-to-value, you simply divide your loan balance by the appraised value of your house. Let’s say your house is appraised at $200,000. Your current mortgage loan balance is $150,000, giving you an LTV of 75%. 

What is Combined Loan to Value Ratio?

Another important factor for lenders is the combined loan-to-value ratio, or CLTV. This is the combined ratio of all loans secured by your home to the assessed value of your home. While LTV considers your primary mortgage loan only, CLTV considers all mortgages  — including the one you’re applying for.

For example, let’s say you want to tap into some of the equity you have in your home. Your home is valued at $200,000. With your current mortgage loan balance at $110,000, you have $90,000 worth of equity in your home. If you want to borrow $50,000 of that through a home equity loan, your CLTV would be:

($110,000 + $50,000)  / $200,000
Where $160,000 divided by $200,000 = 80%.
Discover Home Loans® accepts a CLTV less than 90% with a maximum loan amount of $300,000. 

Significance of Loan to Value Ratio for Home Equity Loans and HELOCS

The 2008 recession and its aftermath brought LTV and CLTV ratios into the spotlight — and made lenders more stringent when it comes to requirements for home equity loans and HELOCs. That’s because many lenders ended up underwriting loans for homes that were underwater. When borrowers defaulted, secondary lenders were unable to recoup their money, as many foreclosures only recouped the lower value of the original loan. Today, home equity loans and LTVs/CLTVs are intertwined; banks and borrowers know that a “good” combined loan-to-value ratio (usually 80% or less) means a borrower is less likely to default on a loan. 

In general, many lenders use a CLTV of 80% as a rule of thumb when it comes to extending loans to borrowers. While high CLTV loans and refinance opportunities exist, these may come with high-interest rates and stipulations including carrying mortgage insurance. Knowing your LTV and CLTV ratios can help you understand your home equity loan and HELOC options — and may help determine how much equity you wish to tap. 

Making sure your credit score is as good as possible can also help you lock into the most competitive rates and terms from lenders.

Factors impacting LTVs

While your LTV ratio lowers as you pay off more of your mortgage to establish more equity in your home, closing with a low LTV can put you in a competitive position for refinancing and HELOC opportunities in the future. Here are some factors to consider regarding your LTV:

• Down payment. Here’s another reason to put as much as possible toward a down payment. Not only will a 20% down payment allow you to avoid private mortgage insurance, it will also ensure that you start your home ownership journey with a 80% LTV. This may allow you to increase your chances for earning approval for a home equity loan in the future.
• Home value. Getting the lowest sale price possible can positively affect your LTV, especially if you purchase a home below its perceived value and therefore, take out a lower mortgage amount. Purchasing a home above its sale price requiring a larger mortgage may mean that your LTV may start at a higher ratio than it would have if the buyer had accepted a lower bid.
• Appraised value. Maximizing the value of your home, via home improvements, curb appeal, and general upkeep can ensure that your home maintains or increases its value, which can help you keep your LTV at healthy levels.

While you can’t control all factors related to LTV, understanding that the ratio will continue to be important through the life of your mortgage — especially if you wish to access a home equity loan or home equity line of credit. Understanding how LTV works can empower you to make financially savvy decisions during the home buying process.

LTVs and Different Loan Types

While 80% is often used as a rule of thumb when it comes to LTVs, different loan types may have different rules when it comes to LTVs. That said, aiming for as low an LTV as possible can help ensure that you’re getting the most competitive loan rates.

FHA Loans 

A Federal Housing Loan (FHA) loan is a type of loan backed by the government for first-time buyers. This type of loan can require as little as 3.5% down payment, but these loans may require a Mortgage Insurance Premium (PMI) which can last for the life of your loan, regardless of your LTV. In addition, FHA loans may have stipulations regarding home equity loans. For these reasons, many home owners use an FHA refinance once they have a certain amount of equity in the home.

VA and USDA Loans 

These government-backed mortgage options are available to certain members of the population. VA loans are available to many current and past service members and USDA loans are available to individuals who live in rural areas and hit certain eligibility criteria. Both of these mortgages have minimal down payment requirements. However, they may also have additional fees, as well as restrictions when it comes to refinancing and additional loans.

Fannie Mae and Freddie Mac

For low-income borrowers, Fannie Mae and Freddie Mac mortgage offerings only require minimal down payments. However, they require homeowners to carry mortgage insurance (which can be cancelled once LTV falls below 80%). While these programs have refinancing options available, they will use LTV to determine loan eligibility. 

While Discover® Home Loans does not currently offer FHA, VA, or other conventional mortgage products, a mortgage refinance is available for loan amounts from $35,000 to $300,000. This is available with zero origination fees, zero application fees, zero appraisal fees, and low, fixed rates.

Ways to Lower LTV and Increase Home Equity

A low LTV can keep you in a competitive position, regardless of your plans for a home equity loan or HELOC. The more equity in your home, the lower your LTV. Here are some ways to lower your LTV if you’re already a homeowner.

Consider refinancing

If you’re in a position to do so, it may make sense to refinance your mortgage. Switching from a long-term, 30 year mortgage to a short-term, 15 year mortgage will increase monthly payments, but it will also pay your principal down more quickly and increasing your home equity. Locking in lower interest rates for the same term can also reduce your overall interest charges over the life of the mortgage loan.

Address necessary repairs

Staying on top of repairs and maintenance can increase the value of your home. Regular roof repairs, gutter cleaning, and painting will help maintain and potentially increase the value of your home. Curbside appeal counts, too: addressing any necessary exterior work, such as paving or landscaping, can maximize your home’s value, which can lower your LTV. 

Improve your property 

This may sound like a catch-22, especially considering that home equity loans are often used to address home improvement projects. But home improvements don’t need to be big to increase the value of your home. Simple improvements, such as repainting, adding insulation, and addressing any issues such as mold, wiring, and plumbing can increase the value of your home. 

Pay more toward the principal