One of several acronyms you'll see popping up quite a bit in mortgage-related documents from your loan officer or on explainer sites for federal programs is LTV: loan to value ratio. This figure is the difference between what you owe on a mortgage and the bank-appraised value of the mortgaged asset -- aka the appraised property value -- expressed as a percentage. Lenders use this figure to calculate risk. When you own a home and have been making payments for a while, this number helps you determine how much equity you have.
Calculating LTV ratio
Divide the amount of the loan by the total value of the property. For example: If you're making an offer on a home that's been appraised at $300,000, and you're putting $30,000 down, the loan is $270,000 and the LTV is 90%.
If you're at the point of shopping for a loan on a home and learning all these new terms right now, the easiest way to understand LTV is via the related layman's term "down payment," which is actually the inverse of LTV. For the example above, the down payment is 10%.
A high LTV ratio means more risk. A good LTV ratio is lower. Put another way, a mortgage with a higher down payment is better because you're asking for a smaller loan.
What is a good LTV ratio?
An LTV ratio of 80% is considered good for conventional loans, but 90% is an LTV ratio that many lenders will work with if you have credit scores of at least 700. For applicants with higher credit scores, even higher LTVs -- so, lower down payments -- may be accepted.
FHA loans, i.e., those insured by the Federal Housing Administration, are what many first-time homebuyers want because FHA-approved lenders will accept the highest LTV ratio on an FHA loan -- as high as 96.5%, which is how people get to buy houses with a 3.5% down payment and at least a 580 credit score. If you have above a 500 credit score, it is possible to get an FHA loan with 90% LTV ratio.
What if your LTV ratio is high?
If your LTV ratio is considered high, the underwriter at your lender may take other factors into consideration or adjust other things to minimize the risk in your loan. These include:
- High credit scores.
- Satisfactory mortgage history (if you've had a mortgage before).
- Tax returns/transcripts to show steady employment history.
- W2 income, verified by pay stubs.
- Cash reserves.
The connection between LTV ratio and PMI
Before you go hunting for the lender who will take the highest LTV, though, make note of one more thing: Lenders consider a good LTV ratio on a primary residence to be 80%. For second homes and investment properties, 75% LTV is what meets the Fannie Mae standard. Since many people do not have 25% of a home's price to put down, there are two ways to work around it:
- Open a line of credit for the difference. For however long you're paying off this line of credit, it will account for a substantial amount of your monthly payments, so even less will go to the principal.
- Pay mortgage insurance for the amount of the loan that is above the Fannie May threshold of 20% LTV. This insurance, commonly abbreviated as PMI, covers the lender, and you have to pay it until you've reached the 20% LTV ratio.
LTV ratios can sound complicated to the uninitiated, but it's actually a simple figure to calculate. And once you understand what makes for a good LTV ratio and how to compensate for a less-than-ideal one, you can better position yourself to get the best mortgage for you.
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