What is a loan-to-value ratio and how is it calculated?

When it comes to obtaining a mortgage loan, understanding the loan-to-value ratio (LTV) can be crucial. LTV is an essential factor as it may directly impact mortgage terms, interest rates, and even your loan approval.

Calculate your loan-to-value ratio

To calculate a loan-to-value ratio, simply divide the mortgage amount by the current value of the property it’s financing and multiple that result by 100:

Loan-to-value Ratio = (Mortgage Amount ÷ Current Home Value) × 100

For example, if you are purchasing a property worth $400,000 and need a mortgage loan for $320,000, the LTV would be calculated as:

LTV = ($320,000 ÷ $400,000) × 100 = 80%

In this scenario, the LTV is 80%.

Significance to lenders

Lenders use the loan-to-value ratio as a tool to help assess risk when offering financing options to homebuyers. A higher LTV may signify there may be a higher risk in lending as the borrower has less equity invested in the property. Lower LTVs may correspond to a lower level of risk for lenders because they indicate that a borrower has more equity in the property may be considered less likely to default on the loan.

Lenders generally have maximum LTV thresholds that they are willing to accept for different loan types. For example, a lender may have a maximum LTV of 80% for a conventional mortgage. When working with that lender, a borrower should expect that a higher LTV than the specific threshold may result in additional requirements such as private mortgage insurance (PMI).

What is combined loan-to-value ratio?

Another important factor for lenders is the combined loan-to-value ratio (CLTV). This is the combined ratio of all loans secured by your home to the assessed value of your home. While LTV considers only your primary mortgage loan balance, CLTV considers the balance of all mortgages you have on a property or are looking to apply for. This may include loans such as home equity loans or home equity lines of credit (HELOCs). 

For example, let’s say you want to tap into some of the equity you have in your home to access cash for a home renovation project. Assume that your home is valued at $400,000. If your current mortgage loan balance is at $300,000, you have $100,000 worth of equity in your home ($400,000 - $300,000 = $100,000). If you want to borrow $50,000 of that through a home equity loan, your CLTV would be:

($300,000 + $50,000) ÷ $400,000 = .875

Multiply that result by 100 to turn it into a percentage value, and you will have an 87.5% CLTV in this example.

Just like with LTV, lenders will establish maximum CLTV limits for borrowing. These limits may vary depending on your chosen lender or due to other factors like applicable state laws and regulations. If you are looking to apply for a second mortgage, make sure to research what options may be available to you before applying.

LTVs and different loan types

Different loan types may have different rules when it comes to LTVs. That said, aiming for as low an LTV as possible may help ensure that you’re getting the most competitive loan rates.

• FHA Loans: A Federal Housing Administration (FHA) loan is a type of loan backed by the government for first-time buyers.  This type of loan may require as little as 3.5% down payment, but these loans may require a Mortgage Insurance Premium (MIP) 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 homeowners use an FHA refinance once they have a certain amount of equity in the home.
• VA and USDA Loans: These government-backed mortgage options may be available to certain members of the population. VA loans may be available to many current and past service members and USDA loans may be available to individuals who live in rural areas and hit certain eligibility criteria. Both 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 help determine loan eligibility.

Ways to lower LTV and increase home equity

A low LTV may help 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 that may lower your LTV if you’re already a homeowner.

• Consider refinancing: If you’re able 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 may increase monthly payments, but typically will also pay your principal down more quickly and increase your home equity. Locking in lower interest rates for the same term may also reduce your overall interest charges over the life of the mortgage loan.
• Address necessary repairs: Staying on top of repairs and maintenance may 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 may count too: addressing any necessary exterior work, such as paving or landscaping, may maximize your home’s value and lower your LTV.
• Improve your property: This may sound implausible, 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 like repainting, adding insulation, and addressing any issues like mold, wiring, and plumbing may increase the value of your home.
• Pay more toward the principal: Yes, some mortgages have prepayment penalties. But that’s a bridge you can cross when you come to it. If your goal is to decrease your LTV, earmarking financial gifts, windfalls, and bonuses toward your mortgage may give you more equity in your home and may allow you to lock into the most competitive home equity loan rates.

How LTV impacts home financing

Your LTV might affect the choices you have throughout the life of your mortgage. But your LTV is not a static number. The more equity you have in your home, and the more the value of your home increases, the more competitive your LTV may be.