What is Loan to Value?
The Loan to Value Ratio (LTV) describes the relationship between a loan amount and the appraised fair value of the asset securing the loan, e.g. property, home, automobile.
Table of Contents
- How to Calculate Loan to Value Ratio (Step-by-Step)
- Loan to Value Ratio Formula
- How to Interpret Loan to Value (High vs. Low LTV Ratio)
- Loan to Value Calculator — Excel Template
- Step 1. Home Mortgage Loan Assumptions
- Step 2. Loan to Value Calculation and Ratio Analysis
- Combined Loan To Value Calculation (CLTV)
- How to Reduce LTV Ratio: Credit Risk Mitigation Methods
How to Calculate Loan to Value Ratio (Step-by-Step)
Lenders often compare the total dollar value of their loan to what the borrower is contributing, which is the value of the property securing the loan.
The loan to value ratio (LTV) measures the relationship between two factors:
- Secured Loan Amount
- Value of Purchased Asset
The loan to value ratio (LTV) is a metric frequently calculated by financial institutions and lenders to measure credit risk, particularly when considering mortgage applications.
The loan to value ratio can be calculated by dividing the loan amount by the appraised property value.
Loan to Value Ratio Formula
The formula for calculating the loan to value ratio (LTV) is as follows.
Since the LTV is often expressed as a percentage, the resulting figure should then be multiplied by 100.
Lenders use the LTV ratio as part of the underwriting process to gauge the amount of risk undertaken if the loan is approved.
How to Interpret Loan to Value (High vs. Low LTV Ratio)
Higher loan-to-value (LTV) ratios tend to be perceived as riskier financing arrangements by most lenders.
- High LTV → More Credit Risk + Higher Interest Rate
- Low LTV → Less Credit Risk + Lower Interest Rate
In the context of real estate mortgages, the LTV can determine the necessary down-payment, the total amount of credit extended, terms of the loan, and more (e.g. insurance policy).
Therefore, a higher LTV can negatively affect the borrower in several ways, such as:
- Higher Interest Rates
- Higher Monthly Payments
- Private Mortgage Insurance (PMI)
- Less Equity in Property (i.e. Smaller-Sized Down Payment)
Typically, banks and lending institutions view an LTV of 80% or less as favorable and are far more likely to offer favorable terms in such cases, i.e. lower interest rates.
Loan to Value Calculator — Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Step 1. Home Mortgage Loan Assumptions
Suppose you have decided to purchase a home currently worth $400,000 in the market based on a recent appraisal.
Since you do not have enough cash on hand to purchase the house all by yourself, you resort to getting assistance from a bank that offers to provide 80% of the total purchase price, i.e. $320,000.
The remaining 20% must be paid out of your pocket.
- Mortgage Loan = $320,000
- Down Payment = $80,000
Step 2. Loan to Value Calculation and Ratio Analysis
The loan to value (LTV) ratio is 80%, where the bank is providing a mortgage loan of $320,000 while $80,000 is your responsibility.
- Loan to Value (LTV) Ratio = $320,000 / $400,000
- LTV Ratio = 80%
Combined Loan To Value Calculation (CLTV)
The combined loan to value (CLTV) measures two mortgages combined against the appraised property value.
For instance, let’s assume that you already have a mortgage but have decided to apply for another.
The lender will evaluate the combined LTV (CLTV), which factors in the following:
- Outstanding Loan Balance on the 1st Mortgage
- Newly Proposed 2nd Mortgage
If the current outstanding loan balance is $240,000 on a recently appraised home at $500,000, but now you want to borrow an additional $20,000 in a home equity loan for backyard renovations, the CLTV formula is as follows.
- Combined Loan To Value (CLTV) = ($240,000 + $20,000) / $500,000
- CLTV = 52%
How to Reduce LTV Ratio: Credit Risk Mitigation Methods
In reality, there is no quick-and-easy method to reduce the LTV ratio, as the process can be time-consuming and require some patience.
One option is to spend more on the down payment before taking out the loan; however, not every homebuyer (or borrower) has this option.
For those who cannot increase the down payment, the best course of action could be to consider waiting to grow your savings and purchase a more affordable home or car with a lower price tag.
While not ideal, the compromise can pay off in the long run — so when the time comes, you can make a larger down payment and own more equity in the property.
Generally, the lower your LTV, the better off you’ll be over the long-term in terms of interest rates and lending terms.
Another consideration is to get your property re-appraised, especially if there is reason to believe that the property value might have risen over the years (e.g. neighboring properties have also increased in value).
If so, refinancing or taking out a home equity loan can become easier.
- Refinancing can be negotiated at a lower interest rate since LTV is based on the appraised value rather than the original purchase price.
- Home equity loans are borrowings against the equity on the property, which is beneficial for the borrower if the home’s value has been re-valued at a higher value.