What Is LTV? Why Loan-To-Value Ratio Matters

The loan-to-value ratio, or LTV, measures the size of the mortgage on a property relative to that property's value. LTV is one of the key elements lenders consider when you apply for a mortgage, mortgage refinance or home equity loan or line of credit (HELOC). LTV is one way that lenders assess risk. Generally, lenders consider a lower LTV to be safer, which means that a comparatively low LTV could help you get a lower interest rate.

LTV is usually expressed as a percentage. Calculating a loan-to-value ratio is fairly simple, though you can make it even easier by plugging numbers into a loan-to-value calculator.

To calculate the loan-to-value ratio, divide the cost of the mortgage by the home’s current value. For example: Say a house is purchased at $400,000, and the mortgage totals $360,000.

The loan to value would be 90%: $360,000 / $400,000 = 0.9. Where did that other 10%, or $40,000, go? That would be the amount of the down payment in this example.

Loan-to-value ratio is one element mortgage lenders look at as they evaluate your finances and consider the terms on which they'll approve your home loan. The lower your loan-to-value ratio is, the less risky you seem to a lender because you've got more equity.

Home equity is the part of the home that you own — the property's value minus the amount you still owe. Having a lower LTV could help you score a lower interest rate.

» MORE: Ways to get a lower mortgage rate

The maximum LTV allowed to purchase a home or refinance varies by lender and the type of mortgage. With government-backed loans and conventional loans, lenders have to follow agency or government-sponsored enterprise guidelines for loan-to-value ratio. But lenders can set their own guidelines for home loans that don't fall into those buckets, like jumbo loans or non-QM loans. Here's a look at the LTV requirements for the four main types of home loans.

Conventional loans

Some conventional loans require down payments as low as 3%, or an LTV of 97%. The trade-off? Typically you'll need to pay for private mortgage insurance, or PMI, on a conventional loan with an LTV higher than 80%. To avoid PMI, make a down payment of 20% or more when buying a home.

FHA loans

Backed by the Federal Housing Administration, FHA loans require a down payment as low as 3.5%, or an LTV of 96.5%.

Borrowers with credit scores between 500 and 579 must put down at least 10% on an FHA loan though. For these borrowers, the required LTV is 90% or less.

With any down payment, FHA mortgages require the borrower to pay for FHA mortgage insurance. To get rid of FHA mortgage insurance, you have to refinance to a different type of loan.

VA loans

VA loans for active and veteran military members require no down payment, so the LTV can be 100%. VA loans, which are backed by the U.S. Department of Veterans Affairs, include a one-time funding fee, which can be paid upfront or rolled into the loan.

USDA loans

Like VA loans, USDA loans don't require a down payment, so the LTV can be as high as 100%. Backed by the U.S. Department of Agriculture, USDA loans are for rural and some suburban home buyers. Instead of requiring mortgage insurance, USDA loans include a one-time upfront guarantee fee and an annual fee paid through the life of the mortgage.

If you're trying to get a second mortgage, like a home equity loan or HELOC, or if you're refinancing a home that already has a second mortgage, your lender will look at CLTV, or combined loan to value.

CLTV is the combined balance of all debt secured by the property divided by the property value.

You can calculate CLTV the same way you would LTV. On a property worth $400,000, say the balance of your first mortgage is $200,000, and you want a $40,000 home equity loan.

The CLTV would be 60%: ($200,000 + $40,000) / $400,000 = 0.6.

Generally, for home equity loans and lines of credit, lenders require the combined loan to value to be less than 80%, though some may go higher.

A good loan-to-value ratio meets the requirements of the type of home loan you want and allows you to meet your homeownership goals.

For example, you might target 80% LTV because you're trying to get the lowest interest rate you can, plus avoid paying PMI on a conventional loan. That monthly savings might outweigh the hardship of having to save up a hefty down payment.

On the other hand, you might reason that a 20% down payment isn't feasible on your timeline, plus PMI isn't forever — it can be canceled once you have sufficient equity. You can focus on other areas, like credit score and debt-to-income ratio, to get the best possible interest rate offers. And if prevailing interest rates drop, you can refinance.

While there are obvious benefits to no-down-payment loans (not having to make a down payment being key), having an especially high LTV could create challenges. Because you didn't make a down payment, you're starting out with no equity in the home. And thanks to amortization — how your mortgage payments change over time to go from being mostly interest to mostly principal — growing your equity may be a slow process.

With lower equity, you're at higher risk if the home were to decrease in value. You could potentially end up owing more money than the home's worth.

Lowering your loan-to-value ratio may be easier said than done. You've got two options, both of which amount to borrowing less: either come up with a larger down payment or look for a less expensive property.

If you're looking at LTV for a refinance or a second mortgage, it's the same idea. Try to chip away at your principal with extra payments to pay off your mortgage faster and bring down the amount you owe. Keep an eye on home values in your area. If your home's value goes up as you keep making payments, the numbers could tilt to your advantage.