What is LTV?
LTV is the acronym for the loan-to-value phrase. Loan-to-value is a financial phrase that used to compare the ratio of loan to the value of the asset acquired. LTV is a common term in building societies and banks. It is often used to express the lien of an initial mortgage as a percentage of the appraised value of the actual property. For example, if a person borrows 150,000 dollars to purchase a home worth 200,000 dollars, then the LTV ration is expressed as 150,000:200,000 or as 75%. The balance of 25% is said to be the lender’s haircut and is covered through the equity of the borrower. Usually, high LTV ration represents high risk for the lender. LTV forms one of the major risk factors assessed by lenders as they seek to qualify their mortgage borrowers.
How LTV is used to Qualify Borrowers
The risk of defaulting on loans always tops the list and informs lending decisions. As the possibility of the lender having to absorb the loss increases, the level of equity also decreases. This means as a loan’s LTV ration goes up, the guidelines for qualifying specific mortgage products gets stricter. In such situations, lenders can opt to ask borrowers with high LTV to purchase mortgage insurance in order to shield the lender in case the borrower defaults. This raises the mortgage cost. LTV ratios that are below 80% are considered low and attract lower rates for borrowers because the risk is lower. Low LTV enables lenders to be considerate of high risk borrowers like those with previous records of late payments, low credit scores, high ratios of debt to income, high cash out obligations or high loans or those with no income. Lenders reserve high LTV ratios for borrowers who have high credit scores and a good mortgage repayment history.