Where is the LTV ratio used?
Banks and mortgage lenders commonly use the LTV ratio when a borrower seeks to obtain a loan on a home, such as a mortgage, home equity line of credit (HELOC), or home equity loan. For a mortgage, the bank or mortgage lender will use the LTV to determine a loan's riskiness. If the LTV exceeds certain thresholds, the borrower might need to pay a higher interest rate and have private mortgage insurance (PMI).
Lenders also use an LTV ratio to determine whether a prospective borrower has enough equity to take out a HELOC or home equity line of credit. They'll often use a combined loan-to-value ratio, or CLTV, that divides the combined value of the existing mortgage plus the proposed home equity loan or line of credit amount by the appraised value of the home to determine its CLTV ratio.
Real estate investors will also use LTV when gauging a property investment's riskiness. A high LTV ratio implies that an investment has a higher risk profile. If market values drop, an investor could lose all their equity in a deal if it had a high LTV. Similarly, investors in real estate debt like to see deals with a low LTV ratio. That gives them more cushion should the borrower default, and they need to foreclose on the property and sell it to recoup their investment.
What is a good loan-to-value ratio?
Most mortgage lenders require an LTV ratio of 80% or below for a conventional loan. If the LTV ratio is higher than 80%, they usually require the borrower to obtain private mortgage insurance. That protects the lender in case of a default where they must foreclose on the house and can't sell it for a high enough price to satisfy the remaining loan value. Meanwhile, borrowers can often obtain a lower interest rate if they have a lower LTV.
