Your credit score. Your down payment. Your closing costs. You may already know about the many different considerations and factors that go into owning a home. But you may not know about one of the most important terms of all: Loan-to-Value ratio, or LTV.
What is LTV?
The LTV plays a critical role in home ownership. It affects not only the amount of your mortgage, but also other forms of lending and investment, including:
- Your ability to refinance your home.
- Whether you need to pay private mortgage insurance.
- How much interest you pay.
Your LTV is the percentage ratio of your home loan when compared to how much your home is worth. For example, if your home is worth $200,000, and you have a mortgage with $150,000 left, then your LTV is $150,000/$200,000, or 75%.
Your LTV is initially determined by how much you take out for a mortgage when buying your home. If you make a $20,000 down payment on a $200,000 home, then your home loan is $180,000 (for the remainder of the purchase price) divided by $200,000, for an LTV of 90%.
Other Factors that Affect LTV
While LTV is initially assessed when purchasing a home, your LTV is also constantly changing. Every time you make a payment to your mortgage against the principal balance (not the interest, as those are considered separate fees), your LTV goes down.
In select cases, your LTV can change due to factors beyond payments. For example, If you make any upgrades of your home that increase its market value, you could reduce your LTV. Using the above example, if you had $180,000 on your $200,000 loan (LTV 90%) and you made $50,000 in upgrades and had your home re-assessed, then the LTV would be $180,000/$250,000, for 72%.
Changing market values can affect LTV as well. When the housing market crashed in 2008, many homes lost value, and were worth less than their loans. This made their LTV ratio over 100%, because their loan now was higher than their home value.
Why is LTV Important?
The primary reason to pay attention to LTV is the need for Private Mortgage Insurance (PMI). This is the insurance that all lenders require on homes with an LTV of 80% or more. Why 80%? Because statistically, homeowners who own 80% of their home or less are more likely to continue to pay for their home, and lenders who are forced to sell a home after foreclosure can usually recoup most or all of their losses.
But LTV is for more than PMI. It affects refinancing, as some lenders will not refinance loans that have a very high LTV. It also affects asset management, as it helps you better understand your investment.
Overall, the LTV is one of the most important numbers in lending, and something all homeowners should be familiar with. For more information about LTV, or any aspect of lending, contact me today!