Mortgage 101

Explained: What is LTV?

By Ashley Wirgau on January, 22 2020
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Ashley Wirgau

Mortgage acronyms got you down? No worries, future homebuyer. Ruoff is here to help – because, seriously, there are so. many. acronyms.

FHA. PMI. APR. ARM. LTV. The list goes on for days, and without a homebuying handbook, you might be feeling a little overwhelmed with all the insider lingo. Stress no more – we’ve come to walk you through one of the most important three letters in the loan approval process.

LTV Explained

Loan-to-value (LTV) ratio is the key component in deciding whether or not a mortgage will be approved. This calculation, integral to determining whether a loan is a good investment for the bank, takes the amount of the loan and divides that number by the appraised property value (APV). The higher the LTV, the higher the risk to the bank that the borrowed money may not be recuperated should the mortgagee default on the loan. 

For example, a sale price of $100,000 with a $20,000 down payment results in a mortgage amount of $80,000. If the house appraises at the sale price of $100,000, the LTV would be 80% ($80,000 divided by $100,000 = 0.80). In general, an LTV at 80% or below is preferable and provides the best chance of approval. As this ratio goes up, not only does the chance of denial go up, but the available interest rate could increase, as well, costing homeowners more money throughout the mortgage. 

And Then There’s PMI  

Additionally, in most scenarios, borrowers with an LTV above 80% are required by their lender to purchase PMI (another one of those pesky acronyms). Private mortgage insurance (or PMI) is an additional fee that the mortgagee pays each month (typically between .5 and 1% of the original loan amount) to insure the mortgage for the lender should the borrower be unable to hold up their end of the bargain. 

Once the mortgagee has reached an LTV less than 80%, enough equity has been built, and the PMI is no longer required. And while this may sound like yet another way to pull money from your pocket, PMI is a positive option for many homebuyers. Should you find yourself in a position where PMI is necessary, review Investopedia’s deep dive into this type of coverage and what it means for homebuyers.

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How to Bring Down Your LTV

To increase your chances of loan approval, it may be necessary to tweak the way you choose to negotiate. For example, a home selling for $200,000 would require a down payment of $40,000 to meet the standard 80% LTV; however, say the home inspection (a vital step in the home buying process) reveals some issues within the property. Many homebuyers will request that the seller corrects these problems before the sale. If the buyer is struggling to meet the 20% down payment, though, it might be a good move to negotiate the sales price instead and handle the fixes on your own dime and time. By driving down the price, you also lower the amount required for the down payment, which could be enough to bring the needed 20% within reach.

Or maybe you’re on the market for a fixer-upper, and you’re holding a pile of cash for the remodel. If this puts a strain on the amount you have available to put down on the front end of the loan, you might reconsider your timeframe. Maybe that kitchen doesn’t need a center island and granite countertops immediately after move-in, and instead, you take the cash on hand to meet the suggested 20% down. There’s plenty of time to build your renovation budget back up once the mortgage has successfully closed. Finally, those struggling to reach the minimum down payment requirements could also explore the various Down Payment Assistant programs to help secure the funds needed to hit that desirable LTV ratio.

Buying a house requires a working knowledge of not only the vocabulary that accompanies a mortgage, but it also demands that homebuyers fully understand how each term affects the lending process. Without a good grasp on LTV and PMI, buyers could be left with severe FOMO when their mortgage approval comes in DOA.