Potential Problems With High Loan to Value Ratios

You may or may not know what a loan to value ratio is, or why it is important that you do when considering refinancing your mortgage.

Simply stated, an LTV or loan to value ratio is the sum you get when you divide the balance you owe on your mortgage by the appraised value of your home. The lower the LTV ratio, the better. Those who have a good deal of equity in their homes will usually have a lower LTV ratio, which means a better interest rate and often a lower mortgage payment as well.

Problems that can result with a high loan to value ratio

If you owe as much or nearly as much on your mortgage as your home is worth, you will have a high LTV ratio when you do the calculating. This is not to your favor if you are considering refinancing your home, or having Private Mortgage Insurance removed from your payment.

The higher this ratio, the more risk a lender faces, which makes it difficult to have your home refinanced. You can also expect to pay a higher amount for your mortgage loan because of this risk. Lenders typically pass the high risks on to the homeowner through higher interest rates and additional or higher lender fees.

Private Mortgage Insurance is often required for those with a loan to value ratio of greater than 80% in order to be approved for refinancing. This insurance typically offers nothing to the homeowner other than higher costs, and is meant to protect the lender from losses due to foreclosure.

Misconceptions about loan to value ratios

A LTV ratio is not always set in concrete due to the fluctuation of the housing market. What one person may perceive as the "fair market value" of a home is not necessarily what another person will place the value at. A LTV ratio is not a strong or concrete numerical percentage and should be considered more of a subjective estimate.

As the housing or property markets change, values and percentages regarding loan to value ratios and fair market values will fluctuate. This means that your LTV ratio may not be the same in 6 months as it is today.

Since this number is such an important component in financing homes and properties, many people find it interesting that such a crucial component seems to be based more on opinion than on actual facts.

Be prepared to have a difficult time refinancing your home if your loan to value ratio is on the high side, as many lenders are simply not willing to assume the risk.