What’s this LTV thing?

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Mortgage percentage changes concept with house and loan percentage symbol. Illustration isolated on white.

LTV, three letters that mean so much when it comes to applying for a mortgage. What do they mean? Loan-To-Value.

The LTV is the ratio of your loan amount to the value of your property. That means that that if your home is worth $300,000 then a 80% LTV would mean a loan amount of $240,000. Seems straight forward enough, right? Well it is and it isn’t. The math is easy. You simply take your loan amount and divide it by your value and convert the result to a percentage (by moving the decimal two spaces to the right and slapping a % on it). The complicated part is figuring out what LTV limits apply to you. Here the rules get a little more conditional and circumstantial. Quick disclaimer here, by the way: Everything I’m saying here is a broad generality and subject to change.

If the loan is a “Purchase” loan for a home buyer then LTV rules depend on the type of loan product. For the sake of simplicity and time I will limit the discussion to Conventional and FHA financing (these are the most common loan products used to purchase a home). Please note that on a home purchase, LTV is based on the lower of the sales price or the value.

If someone is buying a home with an FHA loan then the maximum LTV is 96.5% (meaning the balance of the purchase price, 3.5%, is the minimum down payment). Buyers can always put more down if they choose. There is a small break on the monthly mortgage insurance (more on that in a latter post) at 95% LTV (5% down). FHA loans are generally limited to properties you occupy as your primary residence.

If someone is buying a home with Conventional financing then things become a little more complicated. 97% LTV is possible but not all buyers are eligible for just 3% down. 95% LTV (5% down) is the general rule for a maximum loan-to-value ratio. If a buyer would to go with an 80% LTV (20% down) then mortgage insurance would be eliminated. These LTVs go down if the property has multiple units and/or it is not a primary residence.

Now if the loan is a “Refinance” for a current homeowner looking for new financing the rules can be a little different. There are two different kinds of refinance (refi) loans: Cash-Out refinances where some of the equity in the property is converted to debt and Rate & Term refinances where the rate and/or the term of the loan are changed.

On an FHA Rate & Term refinance one can generally go up to the original 96.5% max. That can be based on the current value or, if you do a streamline refinance, it can be based on the original purchase price and the borrower saves on the cost of the appraisal. If it is a Cash-Out then the max LTV is limited to 95% LTV. Unless your loan amount is over $417,000. Then the Cash-out limit is 85%.

With a Conventional refinance then you can do a Rate & Term refi up to 95% on a single unit property that you occupy as a primary residence and 80% for a rental property. A Conventional Cash-Out would be limited to 80% LTV for a primary residence and 75% for a rental property.

Is that clear enough?

But wait, there’s more! There’s break points to consider, especially as it pertains to pricing out an interest rate for a given loan. As the LTV increases, the risk that the loan will default increases (this is borne out by statistics). A 90% LTV loan is more likely to go into foreclosure than a 70% LTV loan, all other variables being equal. So, with that in mind banks generally assign higher pricing to higher LTV loans. Here’s where break points come into play. The industry, by and large, puts things into buckets (and not just LTVs). LTVs tend to be seen in buckets that span a 5% range.  So LTVs between 90.01% and 95% all fall into the same 95% bucket. An 83% loan is priced the same as a 81% or 85% loan. That means for every 5% you put down you’ll likely get a pricing improvement. Exactly how much changes from day to day and situation to situation. This general rule holds until about 60%, everything lower tends to fall into the same, <60%, bucket.

This important for borrowers to know so that they can gauge the magnitude of the effect of additional down payment when buying a home or how much of their equity then can borrower against when refinance.

Confused? Have questions? Please post a comment or on my Facebook page (see right sidebar) and I will answer to the best of my ability.



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