What is Loan to Value Ratio? – Buy page from WSJ

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For anyone buying a home, your loan-to-value ratio is a key number. Your so-called LTV is a measure of how much your mortgage is in relation to your home’s value and plays a major role in determining whether you’re eligible for a mortgage – and what interest rate you’ll get. The same applies when you want to refinance a mortgage on your existing home, and with other types of loans, such as B. Car loans.

While calculating your LTV should be relatively easy, the process can get tricky during one volatile housing market, when home prices can quickly deviate from the estimates relied upon by lenders. However, to secure the most competitive mortgage rates, you should aim for a loan-to-value ratio of 80% or less. Here’s what you need to know to determine your loan-to-value ratio and how it affects your finances.

How to Calculate the Loan to Value Ratio

The loan-to-value ratio is a way of weighing a homeowner’s debt obligations in relation to a home’s value. Expressed as a percentage, the ratio is calculated by dividing the amount of money to borrow by the appraised value of the property. For example, if you’re buying a $400,000 home at its appraised value and need to borrow $320,000 (after an $80,000 down payment), your LTV ratio is 80%, sometimes referred to as 80/20 .

While the ratio is simple, it’s often used as a quick and easy way to measure a household’s ability to make mortgage payments relative to home value, says Ken Leon, director of equity research at CFRA Research in New York.

Ultimately, lenders can use the LTV to decide whether to lend you at all, and if they do, what interest rate to offer you and whether or not they need Personal Mortgage Insurance (PMI). The LTV ratio also plays a role when homeowners consider refinancing their mortgage or refinancing with a payout

What is a good loan-to-value ratio?

A lower LTV is better than a higher one in the eyes of lenders. That’s because this ratio is an indication of how much equity you have in your home, your ability to make mortgage payments, and relatedly, the lender’s ability to cover the balance of a mortgage if they ever foreclose on the home and must sell. As a result, borrowers with a higher LTV are considered riskier for lenders.

Many lenders aim for 80%, which is considered a “good” loan-to-value ratio – and this refers to the longstanding rule of thumb of a 20% down payment. But just as there is no hard and fast rule as to how much down payment is required, you can still qualify for a loan with an LTV ratio greater than 80%. However, your LTV ratio will likely factor into the mortgage rates that lenders are offering.

“Lower LTV ratios can translate to lower interest rates, but how much lower can depend on the type of loan you want to qualify for, the price of the home, and factors like your personal credit history,” says Alec Quaid, a Certified Financial Planner Denver at American Portfolios. Conversely, homebuyers and refinancers with an LTV ratio above 80% could face higher borrowing costs or fees, he adds.

For auto LTVs, the The same basic principles apply. However, as cars depreciate in value quickly, LTVs in excess of 100% are common. This was recently reported by the credit bureau Experian average LTV was 117% for new cars and 114% for used cars.

Loan-to-value ratios and personal mortgage insurance

If your LTV ratio is higher than 80%, you may need to make some changes to your home buying equation. In particular, you may need to buy private mortgage insurance if you are unable to increase yours down payment.

If you can’t get a 20 percent down payment, getting private mortgage insurance “isn’t the end of the world,” Quaid says. Typically, you can expect to pay 0.5% to 1% of your total loan amount per year for PMI, which means that on a $400,000 loan, you’ll be paying an additional $2,000 to $4,000 each year for this insurance. And even if you can’t reach a full 20% deposit, the more money you deposit can reduce the amount of PMI you have to pay.

It’s important to note that PMI protects lenders – not homebuyers – if you stop making payments on your mortgage. While the costs can be a bit higher, don’t let PMI put you off buying a home as long as you can afford the monthly payment, Quaid advises. Additionally, you can ask your lender to cancel the PMI once you have at least a 20% interest in your home.

How to track home values ​​and how valuations are determined

LTV calculations are based on a home’s estimated value – and as recent years have shown, there are times when this is the case a gap between selling prices and estimated values. If a home that’s selling for $400,000 is appraised for less — say, $360,000 — and you still have to borrow $320,000 to buy it, then your LTV ratio jumps to almost 89 %. Conversely, if an appraisal shows the home is worth more — say, $440,000 — then your LTV drops to almost 73%.

As the housing market warmed in 2020 and 2021, a challenge for homebuyers and mortgage lenders alike was that sale prices exceeded estimated market values, Leon notes. There may still be a discrepancy between sale prices and estimated values, and as the housing market enters a more “challenging” period, lenders must carefully consider the risks involved in approving mortgages for lenders that could be riskier for lenders. – such as those with a high LTV ratio.

You can estimate a home’s value by tracking comparable sales in the area — but ultimately you need an official appraisal, explains Richard Martin, director of real estate solutions at research firm Curinos. A valuation is conducted by an independent appraiser who determines the fair market value of a home based on factors such as the condition of the home, home improvements, and nearby home values. The assessment usually takes one to two weeks Cost $300 to $450, but can cost much more for complicated properties. according to online real estate company Opendoor.

Existing homeowners have an opportunity to improve the rating by making small improvements, cleaning up, or addressing the “edge appeal” of your home. On the other hand, buyers have little control over the appraisal, but you can dispute a low appraisal by providing evidence of home improvements that the appraiser may have missed, errors in the report, or comparable sales that are irrelevant.

If you don’t like the outcome of the review and the dispute proceeds to no conclusion, it may be time to reconsider your purchase decision. If your LTV ratio is greater than 80%, “that doesn’t necessarily preclude you from getting funding,” says Martin. For most borrowers, that means buying PMI. However, some borrowers may seek programs such as those offered by Fanny Mae and Freddie Macthat allow down payments as low as 3%, although these still require PMI.

Loan-to-value ratio and refinancing

LTV doesn’t just apply during the home buying process. For existing homeowners, this ratio shows the amount you owe, or the principal balance on your mortgage, relative to the value of your home – and it will also be important when refinancing.

There are a few factors that work in the homeowner’s favor. First, home values ​​typically increase over time, which helps reduce your LTV ratio. Paying off your mortgage and building equity in your home will also help lower your LTV. As a result, you may be a more attractive borrower when it comes time to refinance.

During a refinance, lenders consider the principal of your mortgage relative to your home’s value, Martin notes. You, in turn, rely on the LTV ratio to determine how much money you can withdraw and what interest rates you are entitled to when refinancing. As with buying a new home, lenders generally want to see an LTV ratio of 80% or less on refinance (including refinance with payout), although requirements may vary for second homes, other types of mortgages, and individual lenders.

When refinancing, you want to get the highest appraisal possible to increase your home’s equity – and then some of those small improvements can potentially add up big.

The advice, recommendation or review in this article is provided by the buy side of the WSJ editorial team and has not been verified or endorsed by our trading partners.

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