A borrower's guide to loan-to-value ratio (LTV)

Whether you're a first-time buyer or a homeowner looking to refinance, there’s a lot to consider in a mortgage application. One important factor is how much your lender is willing to loan you toward the purchase price of the property. In determining this figure, home lenders look closely at several metrics, one of which is your loan-to-value ratio, or LTV.

Loan-to-value ratio (LTV): What it is and how it works

Loan-to-value ratio (LTV) is a number, expressed as a percentage, that compares the size of the loan to the lower of the purchase price or appraised value of the property. For example, a loan of $150,000 toward a house appraised at $200,000 represents 75% of the home’s value. In this case, the LTV ratio is 75%.

LTV is an important figure because it helps your lender assess risk. From the lender's perspective, the more money they lend, the more they stand to lose in the event of a mortgage default. Generally speaking, the more equity the borrower has in a property, the lower the risk of a default.

How to calculate LTV

Calculating a loan-to-value ratio is relatively straightforward. Simply divide the loan amount by either the purchase price or appraised value of the property (whichever is lower), and then multiply by 100 for the percentage. As in our example above, a loan of $150,000 divided by an appraised value of $200,000 gives an LTV ratio of 75%.

Note that when the bank calculates LTV, they typically consider the contracted purchase price of a property, not the asking price listed by the seller. The appraisal is ordered by the mortgage lender but paid for by the prospective borrower.

Do you need a competitive LTV?

A loan-to-value ratio of 80% or below may give you access to more competitive mortgage interest rates. If your LTV is greater than 80%, you may be asked to purchase private mortgage insurance, or PMI. This is an additional insurance protecting the lender from the risk of default or foreclosure on the loan.

Before entering into a purchase agreement, getting prequalified can help you determine how much you might be able to put down and what value of property would help get you to your goal LTV. If you’re in the midst of making an offer, you might also consider increasing the size of your down payment, if possible. Another option is to continue negotiating for a lower purchase price or shopping around for a less expensive property if you’re not set on buying the current property.

Of course, your LTV isn’t the only factor a lender considers when assessing your mortgage application. They’ll also typically require information about your credit, savings and other assets. Importantly, they‘ll usually review your debt-to-income ratio, which is the total of your monthly debt payments divided by your gross monthly income.

LTV and refinancing

When refinancing, your LTV will be based on the current principal balance and the current value of your property. Say you originally borrowed $160,000 against a home you purchased for $200,000. That works out at an LTV of 80%. As you pay off your mortgage (and the principal), your LTV starts to lower. This is already good news for the homeowner. But the impact of your regular mortgage payments isn’t the only factor at play here. Refinancing typically requires a reappraisal of your property and it’s possible that your home’s appraised value has changed since the time of your purchase.

As a homeowner, a higher appraised value tends to work in your favor, increasing your home equity and lowering your LTV. For example, if your home is now appraised at $250,000 compared with its original valuation of $200,000, that further lowers your LTV. By contrast, if your home’s appraised value has fallen since the time of your original purchase, this will likely push up your LTV.

What is combined LTV (CLTV)?

CLTV, or combined loan-to-value, is another acronym you might hear. Combined loan-to-value is calculated just like LTV but combines all the loan balances for all liens on the property - liens like second mortgages, home equity loans or home lines of credit - and not just the first mortgage. Measuring by CLTV tends to increase your loan-to-value ratio, depending on whether you’ve borrowed against your house.

In summary

Loan-to-value ratio (LTV) is an important factor that lenders consider when assessing your mortgage application. Better understanding how LTV works could prove helpful in your home ownership journey. Whether you’re buying or refinancing, LTV is one metric, among others, that helps mortgage providers determine how much they are willing to lend.