Importance of Loan to Value Ratio For Potential Home Buyers

Many people aren't aware that there is such a thing as loan to value ratio until they prepare to invest in a home or property. This is a big factor in determining if you will qualify for a loan, as well as how much interest rates will be. Lenders look closely at three factors in determining whether you qualify for a loan: Credit score, debt-to-income ratio, and LTV or loan to value ratio.

Why the LTV ratio is important

The loan to value ratio lets a lender know how big of a risk you are, or whether you will be more likely to default on the loan. The lower your LTV ratio, the better chances you will qualify for a loan and get lower interest rates. The higher the number, the bigger risk you are in the eyes of the lender.

The formula for determining the loan to value ratio is simple. Divide the property's value (appraised value) in to the amount of the loan. The result is the LTV ratio. Lenders prefer that this number is 80% or less; the lower the LTV ratio, the higher amount of equity you will have in the home or property. For example, if the ratio is 70%, you have 30% equity in the property.

Lenders do not want to loan money against property that is apt to be foreclosed on later on, so determining the loan to ratio value is essential. Frequently, lenders will require a buyer to pay for PMI or private mortgage insurance if the LTV ratio is high, because it helps protect them against risk. This can make your mortgage payment substantially higher.

A low loan to value ratio doesn't guarantee a loan

Even though you may have a low LTV ratio, it doesn't mean you will automatically qualify for a loan.

Lenders look at two other factors very closely, your credit history and debts compared to income. It is usually required that your debt-to-income ratio is within range and that you have fairly good credit in order to qualify for a loan.

A lender may also determine the housing-to-income ratio, which is done by dividing the amount your loan payment each month would be by your gross monthly income.

Even if you have a high LTV ratio, it doesn't necessarily mean that your lender will not approve your loan request. If you have exceptional credit and a minimal amount of debt compared to your income, you may still qualify.