Understanding Loan to Value Ratio and How to Calculate

Simply put, a loan to value ratio is an important factor when you want to get or refinance a loan. This is a figure that you need to know when you want to request the removal of PMI, or private mortgage insurance as well. Before a lender will approve a mortgage or refinancing of a loan, it is essential that they assess the risk involved.

When you wish to take out a second mortgage on your home or want to obtain two separate loans for purchasing one home, lenders typically use a combined loan to value ratio formula to assess the risks involved with the transaction. The lender will usually verify the value of each separate loan, then take the totals in order to figure out how much debt the homeowner will have if the lender grants a second loan.

Once the lender determines the full amount of debt, he/she will compare it to the total value of the property that will be used as collateral for both loans.

How to calculate a loan to value ratio

How you calculate a loan to value ration depends upon whether you are getting an initial loan or already have a loan.

If you are just getting a loan, you will begin by using the purchase price of your property as the value of the property. From this amount, you will subtract the amount that was paid down on the property.

Once you have this figure, you will divide the loan amount by the value (or purchase price) of the property. For example, if the purchase price of the property is $175,000 and the down payment you paid was $35,000, the loan amount is $140,000. To determine the loan to value ratio, you will divide $140,000 by $175,000. Your ratio in this example would be .125, or 125%.

Once you have determined your LTV or loan to value ratio, this is the number you will give to your lender when you request a loan.

What should you do if you already have a loan?

If you are looking to refinance or want to request removal of private mortgage insurance, you will need to have your property appraised. When you own your own home, having it assessed is the only way to determine its true value.

Once you have the appraisal value, find out how much you owe on your home by looking on the most recent loan statement. This will be the amount you will use as the loan value for the equation. When you have these two figures, simply divide the loan figure (how much you owe) by the assessed value of your home to determine the ratio.

Determining the loan to value ratio helps you figure out how much equity you have in your property. The higher the ratio is, the more risk to the lender. Those with good credit are apt to be able to borrow amounts with a higher loan to value ratio due to the fact that the lender will not feel that they are taking as much of a risk as they would be with someone with only average credit.

The lower the ratio, the better the chances that a lender will approve the loan.