Loan to Value (LTV) is the loan amount expressed as a percentage of the property value. LTV reflects the proportion of property that is financed through the particular loan.
The purpose of LTV is to assess the availability of collateral (real estate) to meet loan repayment. The primary source of repayment is the borrower’s income from which the borrower makes monthly payment. In the event the borrower losses the income, the lender falls back on the secondary source of repayment which is the liquidation of the real estate (foreclosure process).
LTV is calculated by dividing the outstanding loan amount by the property value. At the time of purchase, property value is the lower of appraised value and the purchase price. At any other time property value is the fair market value such as the appraised value. Appraised value is the valuation of the property provided by a licensed appraiser. Purchase price is the amount that the buyer is paying to the seller at an arms-length transaction.
At the time of loan origination, the LTV is generally between 0% and 100%. 100% LTV reflects a loan where the borrower is not putting any amount towards the property. In some cases LTV might be slightly above 100% when the lender is financing the real estate as well as the closing costs.
After obtaining the loan, the LTV starts to decline as the borrower makes payments that are applied towards the principal. On interest only loans, the LTV remains constant. When the loan is paid off, the LTV is 0%.
LTV greater than 100% is a situation where the value of the property is less than the loan amount. This typically happens when the property value has fallen after obtaining the loan. The loan is now referred to "underwater mortgage" and exposes the lender to a heightened level of default risk.
Lenders use LTV ratio as a measure of risk. It measures the amount of collateral that is available to cover the outstanding debt. The higher the LTV, the higher is the risk the borrower may default on the loan. A 100% LTV loan means that the lender is providing 100% financing and the borrower has no financial stake in the property. If the market goes down, the borrower may simply walk away from the loan without losing much, other than credit history. For this reason, lenders usually cap the maximum LTV that they are willing to lend up to. Also, as the LTV increases, the criteria for obtaining the loan increase. For example, loans with LTV up to 80% may be given to borrowers having a credit score of 650 or more. However, loans LTV greater than 80% would be restricted to borrowers having credit score above 720.
Traditionally, loans with LTV more than 80% require the borrower to obtain Private Mortgage Insurance (PMI). PMI provides default insurance to the lender. Also, high LTV loans carry a higher interest rate than lower LTV loans.
LTV is not used in isolation. Lenders use various risk indicators such as CLTV , credit score, housing ratio , and DTI , to assess the overall level of risk.
LTV is the outstanding loan amount divided by the property value. It can be expressed using the formula below.
|LTV||=||Loan To Value|
|P||=||Principal amount (original loan/investment amount)|
|PV||=||Property value (Lower of purchase price and appraised value)|
Roland obtains a loan for $75,000. The appraised value is $100,000 and the purchase price is $101,000.
In this case,
|Property Value (PV)||=||$100,000. Lower of appraised value ($100,000) and the purchase price ($101,000)|
Roland refinances his loan with an outstanding balance of $75,000. The appraised value is $90,000.
In this case,
|Property Value (PV)||=||$90,000|
Updated: Nov 24, 2013