Loan-to-value (LTV)

-What is loan-to-value (LTV) -LTV scenarios and the mathematical calculation -Typical borrowing scenarios -Factoring in combined-loan-to-value (CLTV) -Factoring potential private mortgage insurance (PMI)

The amount that lenders allow for borrowing when buying a home or refinancing is based on the loan-to-value (LTV). In short, it determimes what a lender is willing to take; a higher risk, comes with a higher interest rate.

For example, suppose you own a home worth $300,000 and $170,000 is owed on the property. This means the equity is $130,000.

This makes the loan-to-value (LTV) 56.6% ($170,000 / $300,000).

LTV Examples

-$300,000 home value for 80% LTV

-The math: $300,000 x .80 equals $240,000

-$240,000 less $170,000 owed leaves $70,000 to borrow

-$300,000 home value for 100% LTV

-The math: $300,000 x 1 equals $300,000

-$300,000 less $170,000 owed leaves $130,000 to borrow

Most lenders do not allow for loans above 80%; prior to the financial crisis of 2008 the industry allowed for loans up 125%. This means that that for a $300,000 home one could borrow up to $375,000.

In this example, it would be $375,000 - $170,000 equalling $205,000.

An LTV over 100% means money is being borrowed on equity that doesn't exist. Therefore, the more money borrowed increases the risk to the lender and thus, higher interest rates will be commanded.

These loan scenarios were very riskly and it turned out that many lenders were stuck with this toxic debt that borrowers could not pay when financial crisis hit.

Typical Borrowing Scenario

Let's do an example with the lender offering money up to 75% of the home’s value: -Current home value: $400,000 -75% of current value: $300,000 -Size of your mortgage: $250,000 -Amount lent: $50,000

Combined loan-to-value (CLTV)

It is important to note that the LTV is based on a single mortgage; however, a borrower may have a second mortgage, home equity loans, liens, or other credit lines. Therefore, a lender will review the CLTV to assess the buyer's risk of potential default.

For the most part a lender will do business when a CLTV is at 80% and beyond; however, there needs to be a strong credit history to go along with the decision.

Private Mortgage Insurance (PMI)

If a borrower has an LTV of less than 80% on a current mortgage, PMI is not required; however, when obtaining additional mortgages where the LTV goes above 80%, PMI will be required. If this is the case, it is important to factor in the additonal cost on top of the first mortgage payment.

PMI is determined by taking the original mortgaged amount multiplied by the rate (typically between .25 - 2%) and divided by 12 to create a monthly payment amount.

For example a $300,000 mortgage with a PMI rate or 1% equates to $250 per month.

-$300,000 x .01 = $3,000 -$3,000 / 12 = $250 per month

This payment will remain in effect until to LTV reaches 78%. To learn more read PFT #7, What is PMI and How to Get Rid of it.