The loan-to-value (LTV) ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower wants $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87%.
Loan to value is one of the key risk factors that lenders assess when qualifying borrowers for a mortgage. The risk of default is always at the forefront of lending decisions, and the likelihood of a lender absorbing a loss in the foreclosure process increases as the amount of equity decreases. Therefore, as the LTV ratio of a loan increases, the qualification guidelines for certain mortgage programs become much more strict. Lenders can require borrowers of high LTV loans to buy mortgage insurance to protect the lender from the buyer default, which increases the costs of the mortgage.
The valuation of a property is typically determined by an appraiser, but there is no greater measure of the actual real value of one property than an arms-length transaction between a willing buyer and a willing seller. Typically, banks will utilize the lesser of the appraised value and purchase price if the purchase is “recent.” What constitutes recent varies by institution but is generally between 1–2 years.
Low LTV ratios (below 80%) carry with them lower rates for lower-risk borrowers and allow lenders to consider higher-risk borrowers, such as those with low credit scores, previous late payments in their mortgage history, high debt-to-income ratios, high loan amounts or cash-out requirements, insufficient reserves and/or no income documentation. Higher LTV ratios are primarily reserved for borrowers with higher credit scores and a satisfactory mortgage history. The full financing, or 100% LTV, is reserved for only the most credit-worthy borrowers.
In the United States, conforming loans that meet Fannie Mae and Freddie Mac underwriting guidelines are limited to an LTV ratio that is less than or equal to 80%. Conforming loans above 80% are subject to private mortgage insurance. For properties with more than one mortgage lien, such as stand-alone seconds and home equity lines of credit (HELOC), the individual mortgages are also subject to combined loan to value (CLTV) criteria. The LTV for the stand-alone seconds and HELOCs would simply be their respective loan balance as a percentage of the total appraised value of real property. However, in order to measure the riskiness of the borrower, one should look at all outstanding mortgage debt as a percentage as a percentage of the total appraised value of real property (CLTV).
Here is the calculation.