Why Loan to Value Ratio is So Crucial When Buying a Home

It is essential that you understand what a loan to value ratio is when applying for a mortgage loan, as this is one of the most important factors considered by lenders to determine their risk in lending you money. The lower the LTV ratio, the better your chances of getting the loan and having a lower mortgage payment.

How do you know what a good LTV ratio is?

Typically, lenders like for the loan to value ratio to be 80% or less. The higher your LTV ratio, the more risk the lender assumes in financing your mortgage. Here is an example to help you understand how to calculate this figure:

The appraised value of the home you are looking to finance is $150,000
You want to pay 20% down on the loan, which would be $30,000, leaving $120,000 as the total loan amount. By dividing the price of the property by the amount you wish to finance ($120,000), you will see that this is an 80% loan to value ratio.

80% or less is usually considered a good LTV ratio to most lenders. To put it simply, the more you pay down on a home, the lower the ratio and the better likelihood you will get financing.

Why do lenders care if the loan to value ratio is higher?

When an LTV ratio is high, say 90% or higher, the lender is at a higher risk of the borrower defaulting on the loan.

Whether you are looking to refinance your home or are trying to purchase a new home or property, it's smart to save up a substantial amount of money for a down payment. While some lenders will finance your mortgage loan at a higher loan to value ratio, the interest rates will be considerably higher and they may require PMI (private mortgage insurance) on the loan to protect themselves in case of default.

Many lenders will simply not grant you a loan if the LTV ratio is too high. It is in your best interest to pay enough down on a property so that this number is 80% or lower. Not only will the lender feel more secure in granting you the loan, you will be better off due to lower mortgage rates.

Loan to value ratio is one of the most important factors in determining whether or not you qualify for a mortgage loan, so be sure you understand how it works.