What is loan-to-value ratio?

When you apply for a loan, lenders will typically review your credit history and other financial factors like your debt-to-income ratio and credit scores. They’ll also probably consider your loan-to-value ratio to determine how risky your loan may be.

A lower loan-to-value ratio indicates to the lender that you may be less likely to go “upside-down.” In the case of a car loan, this is when you owe more on the car loan than it’s worth on the market. A bigger down payment can help lower your loan-to-value ratio.

• How to calculate your loan-to-value ratio
• Why your LTV ratio matters
• What your loan-to-value ratio should be
• Tips to lower your LTV ratio

How to calculate your loan-to-value ratio

Your loan-to-value ratio, or LTV, is usually expressed as a percent. To calculate your LTV ratio, divide the amount of your loan by the appraised value of the asset securing the loan.

For example, say you want to purchase a home for $200,000, which is also its appraised value. If you have $40,000 for a down payment, you would need a $160,000 loan.

The LTV would be the loan amount of $160,000 divided by the appraised value of $200,000, which is 0.80, or 80%. Your LTV is 80% of the property’s value.

Your LTV ratio can be one indicator of whether you can afford the home or vehicle you want.

Why your LTV ratio matters

The higher your LTV ratio, the riskier your loan may appear to lenders. Also, when you make a smaller down payment, you have less equity — or ownership — in your property.

That can be problematic for the lender because if you default on a loan, the lender might not be able to recoup its loss by selling your property.

As a borrower, there are several ways a higher LTV ratio could affect you.

• Higher interest rate: A high LTV ratio may mean that you have to pay a higher interest rate on your loan. Over time, that can make a significant difference in the total amount you pay for your loan.
• Private mortgage insurance: If you decide to refinance your mortgage, some lenders may require you to get private mortgage insurance, or PMI, if your loan-to-value ratio is too high. If you’re just taking out your first mortgage, lenders usually require PMI if your down payment is less than 20% of the home’s value. Adding PMI to your loan could increase your monthly mortgage payment.
• Higher monthly payments: If your loan-to-value ratio is too high it can impact your loan terms, like your interest rate. If that’s the case, it can lead to a higher monthly payment that can strain your budget and make your loan much more costly over the long term.
• Refinancing: If you want to refinance your mortgage or auto loan, a lower LTV ratio may help you qualify for better interest rates.
• Building equity in your asset: A higher loan-to-value ratio indicates that you have less equity in the asset. Putting down a larger down payment or getting a less expensive car or home to get a lower loan-to-value ratio can put you on track to build more equity in the asset. For example, if you decide you want to take out a home equity loan or line of credit, having more equity in your home can really pay off.

Calculate your equity by taking the amount your property is currently worth and subtracting the outstanding loan amount on the property.

What your loan-to-value ratio should be

LTV ratio requirements will vary by loan. But having a lower LTV ratio is one factor that could help you get more favorable loan terms.

If you’re considering a conventional loan to purchase a home, the going wisdom is to aim for an LTV ratio of no more than 80%. Anything above that may come with additional costs, one of them likely being for private mortgage insurance. This could add hundreds or even thousands of dollars to your payments.

Mortgage loans backed by the Federal Housing Authority accept lower loan-to-value ratios. The borrower must make a down payment of at least 3.5% of the appraised value of the home, leaving an acceptable LTV ratio of 96.5%. But remember: With a down payment that small, you’ll have to pay mortgage insurance, which protects the government and lenders in case of default. So you’ll need to pay both an upfront and annual premium for this insurance coverage.

Certain USDA loans and VA loans don’t require down payments, therefore allowing a 100% LTV ratio. In order to qualify for these loans, you’ll need to meet specific requirements for loan approval.

Tips to lower your LTV ratio

There are ways to lower your loan-to-value ratio, which may ultimately help you build more equity in your property.

• Increase your down payment: If your loan-to-value ratio is relatively high, it may be a good idea to increase your down payment before you take out a loan. If you don’t have enough money to do that, consider waiting until you can save more.
• Lower your purchase price: If you don’t have a big enough down payment and can’t wait to save more, you can decrease your LTV by selecting a car or home that costs less. Compromising a bit on things like square footage (for a home) or mileage (for a car) could make you financially stronger in the long run.
• Get your home reappraised: Ideally, your home will appreciate over time — it’s possible for the value to go up significantly within a few years of buying it. If you want to refinance your home or take out a home equity loan or line of credit, a reappraisal can help you get a better idea of your home’s value and your equity in your home. It could also give you an idea of whether your LTV has decreased enough to request to have your PMI removed.

Bottom line

When you apply for a loan it’s important to understand the financial implications of a high loan-to-value ratio. Lowering your LTV ratio may put you in a better financial position to receive a better interest rate and help you save money over the life of your loan.

Calculate your PMI

Get an idea of how much private mortgage insurance you may have to pay if you get a mortgage.