Lenders are always looking for the best ways they can reduce the risk of losing their money when lending. On the other hand, borrowers are always looking for opportunities to give them the maximum loan possible. When it comes to giving mortgages, one of the longest loans, lenders check at the loan-to-value ratio, also known as the LTV ratio. It is a way of assessing the risk involved in approving a mortgage to a certain applicant.
Simply, higher loan to value ratio loans and mortgages have a high risk and they attract high interest rates. Lenders feel safer when they charge higher interest rates although this further strangles the borrower who might have challenges paying for the loan.
How the Loan to Value Ratio is Calculated
Both the lender and borrower need to be on the same page when calculating the loan to value ratio. So, it all starts by calculating it, and this should be clear to both parties.
The loan to value ratio is arrived at by dividing the mortgage amount borrowed by the appraised value of the property. The higher the deposit you can raise for a home, the lesser the loan to value ratio and the lower the interest rates.
Instances When Loan to Value Ratio is Used
As mentioned, the LTV ratio is commonly used in mortgage underwriting but will make it easier to comprehend if break it further.
- Buying a home process – This is a normal mortgage that many people apply for. If the lender will finance a high percentage of the home buying, the loan to value ratio will definitely be high.
- Refinancing a current mortgage – When you want to reduce the burden of your monthly payments of a current mortgage, you can refinance it. With this option, you will still have to go through the LTV ratio process.
- Borrowing against a property – If you have a house or any other property that you can borrow against, the property will be appraised and used to calculate the LTV ratio.
Which is the Best Loan to Value Ratio?
The best LTV ratio is the one below 80%. According to many lenders, this is where borrowers get the best interest rates. They consider the loan a low risk and easy to recover through the sale of appraised assets or property.
As a borrower, you can reduce the LTV ratio as low as possible by raising a deposit when financing a home or borrowing against just a portion of the existing accumulated equity or property. This way, the lender will be in a position to reduce risk and give you the best interest rates.
In case the LTV ratio is above 80%, the interest rates will significantly increase. The borrower will also be required to get an insurance cover to protect them if they default. However, you still have chances of going home with a loan if you meet these qualifications.
With these insights, it is clear that the loan to value ratio is something crucial to both the lender and borrower. So, be informed when borrowing.