Loan to Value
Mortgage Dictionary -> Loan to Value
There are many things that lenders consider when reviewing applications for mortgages. One of the most important things is the Loan to Value ratio. Yet it's also one of the most misunderstood terms in all of finance, as most borrowers do not understand what it is and its significance. If you're one such borrower who doesn't get it, then you'll want to read on.
What is Loan to Value?
The loan to value ratio is a mathematical calculation which expresses the amount of the loan against the value of the property. It is calculated by dividing the amount of the loan by the assessed value of the property, and then multiplying this number by 100 to get the percentage.
Suppose you want to take out a loan of $125,000 for a property that is appraised at $140,000. To get the loan to value ratio, you'd divide 125000 by 140000, which would yield 0.89 or, after multiplied by 100, 89%. This means that your loan to value ratio is 89% - a number considered too high by many lenders.
Why is the Loan to Value Ratio Significant?
Simply put, many lenders depend on this ratio to tell them what borrowers are really worth dealing with. A high loan to value ratio usually that which is above 75% - tells lenders that the borrower in question is a bit of a risk, even if they do have good credit. This can result in either the borrower being turned down, or being given a loan with a much higher interest rate.
The loan to value ratio can also be the determining factor in whether or not mortgage insurance is necessary. Mortgage insurance protects the lender in the case of the borrower defaulting, so those with loan to value ratios of greater than 75% are usually asked to purchase this insurance before they are given financing. This insurance can, of course, cause the monthly payments to go way up, which is why many people try to avoid it.
Why Loan to Value Ratio Should I Aim For?
Generally speaking, anything below 75% is considered to be good, though if you are able to go lower than this, you'll be treated to far lower interest rates and lower monthly payments.