Loan-to-value ratio

The loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. The term is commonly used by banks and building societies to represent the ratio of the first mortgage line as a percentage of the total appraised value of real property. For instance, if someone borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000 to $150,000 or $130,000/$150,000, or 87%. The remaining 13% represent the lender's haircut, adding up to 100% and being covered from the borrower's equity. The higher the LTV ratio, the riskier the loan is for a lender.

The valuation of a property is typically determined by an appraiser, but a better measure is an arms-length transaction between a willing buyer and a willing seller. Typically, banks will utilize the lesser of the appraised value and purchase price if the purchase is "recent" (within 1–2 years).

Loan to value is one of the key risk factors that lenders assess when qualifying borrowers for a mortgage. The risk of default is always at the forefront of lending decisions, and the likelihood of a lender absorbing a loss increases as the amount of equity decreases. Therefore, as the LTV ratio of a loan increases, the qualification guidelines for certain mortgage programs become much more strict. Lenders can require borrowers of high LTV loans to buy mortgage insurance to protect the lender from the buyer default, which increases the costs of the mortgage.

Low LTV ratios (below 80%) carry with them lower rates for lower-risk borrowers and allow lenders to consider higher-risk borrowers, such as those with low credit scores, previous late payments in their mortgage history, high debt-to-income ratios, high loan amounts or cash-out requirements, insufficient reserves and/or no income. Higher LTV ratios are primarily reserved for borrowers with higher credit scores and a satisfactory mortgage history. Full financing, or 100% LTV, is reserved for only the most credit-worthy borrowers. The loans with LTV ratios higher than 100% are called underwater mortgages.

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