You might hear the term loan to value or LTV used a lot when you’re searching or applying for a mortgage. It might even be the deciding factor in your mortgage approval. What exactly is Loan to Value (LTV) and how might it affect your next mortgage?
Loan to value is the ratio of the loan amount to the purchase price or appraised value; whichever is less. You can easily calculate the loan to value by dividing the loan amount by the purchase price or appraised value as seen in the example below:
Appraised Value: $500,000
Loan Amount: $400,000
$400,000 / $500,000 equals .75 or 75% loan to value.
As you can see, it is very easy to calculate loan to value and it’s also quite important because it is a principal loan characteristic that is used to asses mortgage risk. If the LTV is too high, you might not get the loan you had hoped for. If the LTV is too low, there’s really no negative effect. Lenders love low LTV loans because if you should default on your mortgage, the lender has a very good chance of recouping their investment if the house is foreclosed on. We all hope that doesn’t happen of course.
Most people are interested in the maximum loan to values or the loan to value at which you do not have to pay mortgage insurance. In the case of conventional mortgages, the LTV must be 80% or less in order to not have to pay mortgage insurance. In the case of FHA mortgages, no matter what the LTV is, you will pay a mortgage insurance premium on FHA mortgages for at least 5 years.
Conventional loans allow LTV’s of 95% unless it is an area where property value has been declining. FHA purchases allow LTV’s of 97% and 95% on a cash out refinance.