Understanding Loan to Value Calculations

When most people think about mortgages, they focus on credit scores, points, term and interest rates. The loan to value ratio offered by your lender, however, should not be overlooked.

Lenders are odds makers when you get to the heart of things. Why? With every loan application, they calculate the odds on various outcomes. What are the odds that you will meet the monthly payment? What are the odds your current total debt excluding the loan will remain manageable? What are the odds you will have the necessary source of income on a continual basis, to wit, how long will you hold your job? While all of these issues are couched in the mortgage industry as loan terms, their combined results give the lender a picture of whether you are a good risk.

The loan to value ratio for a purchase is another aspect that fits into the evaluation by the lender. The loan to value ratio is know in the mortgage industry as LTV. The LTV is simply the value of the prospective home divided by the amount you are applying for in your loan package. If a home has a valued of $400,000 and you are asking for a $300,000 loan, the LTV is 75 percent. Put in simple terms, you are willing to put a $100,000 payment down. Importantly, the ratio is determined by using the appraised value of the home, not the sales price.

The LTV ratio is often overlooked by borrowers when applying for a loan. This is a huge mistake. The LTV is a major factor in swaying a lender to either approve or reject a home loan application. Why? In many ways, the LTV represents your credibility. The more of your own money you are willing to put down at the outset of the transaction, the more credible you are to the lender. In the example above, a 25 percent down payment tells the lender you are serious about the purchase and protects the lender from some risk. If you default, there will be plenty of value in the home for the lender to recover their investment. If the home depreciates, it will be you who loses value, not the lender. These issues go a long way to making a hesitant lender more confident about you as a borrower.

If you have shaky credit or some other weakness in your loan application, consider raising your down payment amount. The more you put down, the more the lender is willing to overlook.

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