When you purchase or refinance a loan, your LTV ratio helps lenders determine whether working with you is worth the potential risk. Home financing can get really complicated, really fast, so examining your LTV for yourself can help you navigate your next financing decision more easily.
What Is LTV?
A lien-to-value ratio or loan-to-value ratio (LTV for both) is a risk assessment that lenders consider before approving home financing. The LTV ratio describes how much you owe on a property, versus how much of the appraised value is yours in equity.
Lenders use the LTV ratio as part of their calculation of how likely it might be that a borrower could default on the loan. Generally, the higher the LTV, the higher the risk.
Lien-to-value vs. loan-to-value ratio
It’s important to note that the terms “lien-to-value” and “loan-to-value” are similar, but not interchangeable. You might see loan-to-value ratio more often, since mortgages and other home loans are the most common types of home financing. Lien-to-value applies in cases where you’re using an alternative to loans for financing. The financing party may hold a lien (i.e., a legal claim) on the property as security to protect their financial interest, but the type of agreement may not classify as a loan. A home value investment from Noah for example is not a traditional home loan, and therefore uses the lien-to-value ratio vs. the loan-to-value ratio.
Other key differences between Noah’s home equity sharing program and a traditional home loan include:
- No monthly repayment program: Once you get funding through Noah, save money on your own schedule. You won’t need to pay Noah’s share until the end of the term.
- No interest: Typical lenders earn money through interest on loans they extend. Noah’s financing comes without interest.
- Shared gains and losses: With a traditional loan, you repay the principal balance, plus any interest and fees. Noah shares part of the value of your home, so the amount due at the end of the term varies depending on how much your home has appreciated (or even devalued).
Both lien-to-value and loan-to-value may go by the LTV acronym. In this post, we’re talking about lien-to-value.
How Is Lien-to-Value Calculated?
Calculating your LTV is simple. Take the amount you’re borrowing or financing on your home and divide by the appraised value of the property.
For example, imagine you own a $100,000 house, based on the most recent appraisal. You have $30,000 in equity, and the remaining $70,000 is financed through a third party. The equation to find your LTV ratio looks like this:
- 70,000/100,000 = 0.70, or 70%
LTV ratio is usually expressed as a percentage, rather than a decimal value, so that comes to 70%. If you paid off a portion of what you owe and released a lien, the LTV will decrease.
What Is a Good LTV Ratio?
Your LTV ratio doesn’t tell the whole story about whether you’ll be eligible to secure a mortgage, a home equity loan, a HELOC, or other home financing. Lenders look at various factors that inform them about your financial stability. However, LTV ratio can play a big part in the interest rates and other terms a financing institution might offer you.
Generally, the greater the share of your home that you own, the better your chances of getting the most favorable terms. Lenders and financial institutions like to see applicants who have been able to build a lot of equity in their home. That means a low LTV ratio (i.e., you owe a relatively low amount compared to the value of the home) is typically a good sign. Applicants with lower LTV ratios often get lower interest rates, in cases where interest applies, and they may have an easier time getting approved than applicants with a high LTV ratio.
What Is a Good LTV Ratio for a Home Equity Loan?
Real talk: If you’re reading this post, there’s a good chance you’re mostly interested in a simple, straightforward definition of what counts as a “good” LTV ratio. We dove into some background because it’s worth understanding how the factors on your financing application work, and because not all lenders and financial institutions base decisions on the exact same LTV ratio. That said, it’s also true that there are specific numbers that can often make the difference.
For most mortgage and many home-equity applicants, the magic number is 80%. If your LTV ratio is at or below 80%, you’ve got a very good chance at getting approved at the lowest available interest rate. That’s why the “golden rule” of real estate down payments is to put in 20% — it gets you to that 80% LTV.
Higher LTV ratios often won’t exclude borrowers from being approved, but the interest might be higher. Conventional mortgages also typically require private mortgage insurance (PMI) for applicants over the 80% mark. PMI can add tens of thousands of dollars to your payments over the life of the loan.
How does a HELOC factor into my LTV?
Home equity loans and HELOCs often won’t require PMI, even if you’re over 80% LTV ratio. On the other hand, there are also HELOCs that offer their best rates for applicants with a 70% or lower LTV. Compare lenders and read fine print to find the offer that works for you. A sample LTV could look something like this:
- $400,000 remaining mortgage balance on a $1,000,000 home + $150,000 home equity loan = $550,000
- $550,000/$1,000,000 (the total appraised value of the home) = 0.55, or 55%
A HELOC can have a different impact on your LTV depending on which stage you’re in. In the draw period, where you can still access funding through your home equity line of credit, some lenders may count the full line of credit in your LTV, rather than what you’ve currently withdrawn (because they want to account for the possibility that you might withdraw more). Once you’re out of the draw period and in the repayment period of a HELOC, lenders may only count the balance you actually took from your equity.
Plan Your Home Financing Using LTV Ratio
If you have a home improvement project in mind, or another goal you’d like to fund by tapping home equity, you can calculate your budget for the project and determine the LTV ratio for that specific project. For example, if you own a $500,000 home outright and the souped-up backyard of your dreams will cost $40,000, your LTV when you apply for financing for the project will be 8% (40,000/500,000 = 0.08).
If you haven’t paid down your home, add that $40,000 estimate to your mortgage and any other liens you have on the home. If your debt balance already accounts for 75% of your home’s value, you’ll know that even a $40,000 project may be too big to add to your LTV right now, because it will take you over 80% and make lenders less inclined to work with you.
From there, you can calculate how much to pay off on your other mortgage or home equity loans and make a plan to bring your LTV down enough to accommodate the financing you want. This can help you plan the best timing to take on additional financing and realize your goals.