Everything you should know about Loan to Value
Countless terms in the banking industry need clarification for newcomers. There are many terms used by financial institutions when they sanction loans or decide whether an applicant is eligible for them. Banks or lending companies use a loan to value ratio (LTV) to determine how much loan you may qualify for.
A loan-to-value ratio is an important number for anyone buying a house. Figuring out your LTV is relatively simple, but appraised values can diverge rapidly in an unstable market.
Wondering where you can gather all the details about LTV? You are on the right page. Keep reading the blog to know everything about LTV in Canada.
What is the loan-to-value ratio?
Loan-to-value (LTV) ratios are a measure that lenders use to determine the amount of risk they take by extending a secured loan to the borrower. Thus, it determines whether a loan is secured by assets worth more than the loan amount.
An LTV of 50% implies that a lender is lending half of the asset’s value. The higher the LTV, the more likely the lender would be at risk if the borrower couldn’t repay the loan, resulting in a higher potential loss to the lender.
You can even use the line of credit for the down payment on the property.
Once a legend Paul Volcker said ‘If you don’t have bad loans, you are not in business”.
LTV Calculation
Loan-to-value ratios, or LTVs, are typically expressed as percentages. You can proceed with the loan to value calculation by dividing the loan amount by the collateral asset’s value.
Consider the following example: You want to purchase a home for $220,000. Its appraised value is also $220,000, and a down payment of $60,000 would require a loan of $180,000.
Taking the $180,000 loan amount and dividing it by the $220,000 appraised value, the LTV is 80 percent. Depending on your LTV ratio, you can afford the house or car you want.
Loan-to-value ratio: What’s a good one?
Your LTV should be 80% or less – this will qualify you for better loan terms and save you hundreds of dollars in mortgage insurance.
Having a high ratio mortgage over 80% often means paying mortgage insurance. If there is a default on loan, mortgage insurance allows the lender to take on greater risks in lending you the money.
What You Can Do To Improve Your LTV Ratio On A New Home
You can get a higher loan-to-value ratio when refinancing or purchasing a home. Here are the possible ways to enhance the LTV ratio:
Put down a larger amount
If you make a larger down payment on a home, your debt to value ratio will be lower. Lenders and mortgage investors regard it as one factor that indicates your loan’s potential risk. From a lender’s perspective, when a buyer invests more of their money upfront, they will be seen as a serious and invested borrower, which the lender will consider.
An increase in equity in the home is also attributed to larger down payments. For example, a $100,000 loan with a $40,000 down payment will have an 80 percent LTV since the home was appraised for $120,000. Higher down payments result in lower LTV ratios (the better).
Invest In A Less Expensive House
A second option that can work well for homebuyers with limited finances and tight budgets is to focus on houses that aren’t as expensive and have lower down payments. As a result, your LTV will be reduced, and you may be able to obtain a better loan.
The equation is already available to you. This implies that you may manipulate the variables (appraisal value and loan amount) to obtain a lower, more desirable LTV. If you select a home with a lower appraised value, your LTV ratio will be improved.
LTV ratios: Why they’re important
Having a high LTV makes your loan look riskier to lenders. As a result of a smaller down payment, you have a lower amount of equity in your property or a lower sense of ownership over it.
As a result, that can cause problems for the lender because if you default on your loan, the lender will not likely be able to make up their loss by selling your property.
There are several ways in terms of how an increased LTV ratio could affect you as a borrower.
Higher interest rate
The LTV ratio of your loan may have an effect on the higher interest rate that you pay. If you do this over time, you can make a substantial difference in the overall cost of your loan.
Private mortgage insurance
Your home’s loan-to-value ratio might encourage you to get private mortgage insurance when refinancing your mortgage.
Most lenders require PMI for home buyers taking out their first home mortgage ratio and putting less than 20% down on their homes. If you add PMI to your loan, you may have to pay a higher monthly payment for your mortgage.
A higher monthly payment
In the case of high loan-to-value ratios, it can adversely affect your loan terms, including your interest rate. It could push up your monthly payment, straining your budget and increasing the overall cost of your loan.
Refinancing
When refinancing your home or auto loan, a low ratio mortgage may qualify you for a better interest rate.
The equity in a property can be calculated by taking its current market value and subtracting the amount outstanding on its loan from its current market value.
Tips for reducing your LTV
The loan-to-value ratio can be lowered in many cases, and it’s possible to do so in a way that helps you create more equity in your property in the long run.
Make a bigger down payment
When your loan-to-value ratio is high, consider increasing your down payment. Depending on your money, you should defer a purchase until you can save more.
Purchase at a lower price
If you don’t have a significant down payment and aren’t able to wait for more savings, you can reduce your LTV by selecting a cheaper car or house. When you buy a home or car, compromising on things such as square footage might make you more financially stable in the long run.
Reappraise your home
The value of your home may increase significantly within a few years of purchasing it – that’s ideal. When considering refinancing your home or taking out a home equity loan, a reappraisal can help you determine the value and equity of your house.
Depending on your LTV, it can also give you an idea as to whether your PMI has reduced enough for you to request a reduction on your PMI.
Conclusion
A high loan-to-value ratio has a lot of financial implications, and it is essential to understand these implications before applying for a loan. In general, lowering the LTV ratio of your loan will benefit both yourself and your lender in the long run since you can qualify for a better interest rate and save more throughout your loan.
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FAQs
What is the maximum loan to value?
Generally, a loan-to-value ratio of 80 percent or less is considered good. In situations where the LTV goes above 80%, borrowers can face higher borrowing costs, be required to obtain private mortgage insurance to cover their risk, and may have their loan applications denied if their LTV exceeds 80%. Many consider a loan-to-value ratio above 95% unacceptable.
What is the maximum loan-to-value for a refinance?
A loan amount of $36246.44 and up to $90616.12 is considered to have a maximum LTV ratio of 80%, while a loan amount of $90616.12 and greater is considered to have a maximum LTV ratio of 75%.
What is a good loan-to-value ratio in Canada?
While getting approved for a mortgage refinance with an LTV ratio of 95% is feasible, aiming for an LTV ratio of 80% or fewer increases your chances of getting a reasonable rate.
What is loan-to-value in simple terms?
Loan-to-value (LTV) ratios compare mortgage payments to the home’s appraisal value. Low LTV ratios result from high down payments. Lenders will likely use the LTV to decide whether you qualify for a loan and whether or not private mortgage insurance is required.
What does a 75% LTV mean?
Generally, lenders offer LTVs between 50% and 95%, which puts 75% at the lower middle of the range. It is important to note that lenders are taking on less risk when you have a 75% LTV, so you have a wide selection of competitive options to choose from, which means that your total costs will be lower than those you would have a higher LTV.
What does up to 80% loan-to-value mean?
The loan-to-value ratio measures how much of the mortgage is compared to the property’s value in terms of a loan-to-value ratio. A percentage is used to express this. A $110,000 mortgage on a $130,000 property provides a loan-to-value of 80% since you received a loan for 80% of the property’s value.
