A home mortgage. Just about everyone knows what a mortgage is. From homeowners to renters and even children.
Even if you yourself don’t currently have a mortgage or make mortgage payments, you probably already know what a mortgage is and why paying it is important.
Except, there are some things about mortgages that you don’t know. One example of that is LTV.
What is LTV? And what effect does LTV have on your mortgage and your monthly mortgage payments?
What is LTV
So, before we can talk about LTV’s effect on mortgages, we should probably talk about what LTV stands for and what that even is.
Simply put, LTV stands for Loan-To-Value.
Great! Now that you know what the acronym stands for you’re probably asking yourself “Okay… but what does that mean?”
The loan-to-value ratio is a system used by mortgage lenders to decide just how risky any given loan is.
Obviously, mortgage lenders have to be careful about lending money. They must pay attention to who they are lending to, how much they are lending, and how risky that loan is for them from a business standpoint.
If mortgage lenders were out there just giving out loans to anyone who asked for one, they wouldn’t stay in business for very long.
And the loan-to-value ratio is one way they can make sure the loans they are giving out are relatively safe for them. The lower the LTV the safer the loan is for them, and the higher the LTV the more risk that is involved with that loan.
How Does LTV Work?
A ratio is a comparison of two or more numbers and their sizes in relationship to one another. So, the loan-to-value ratio works by comparison just like any other type of ratio.
It is comparing the loan balance to the value of the home (according to the appraisal).
So, for example, if you’re looking to take out a loan for a property with the loan amount being $100,000 and the appraised value of the home is $115,000, then your LTV is going to be 87%.
Really, in order to calculate your LTV, all you need to do is take the loan amount and divide it by the home’s appraised value. That will leave you with a decimal that you then turn into a percentage and that percentage is your loan-to-value ratio.
$100,000 / $115,000
Move the decimal point to the right two places and that leaves you with 86.9%
Simply round up and you have your LTV of 87%
That is how your mortgage lender will determine your LTV. And if your LTV is above 80% it is typically considered a higher risk. So many mortgage lenders will only approve you for a mortgage loan with an LTV of 80% or lower.
That is why a home deposit is necessary. The higher the initial deposit that you make on your home, the lower your LTV will be.
So let’s say that the home you are looking to purchase is the $115,000 property.
That means, in order to make your loan-to-value ratio 80% your mortgage loan can only be $92,000. So that means you need to figure out just how you are going to pay the rest of the $23,000 gap.
You either need to make the full deposit of $23,000 or, figure out how to get the seller to come down on their sales price. The better your credit score the less you have to worry about your LTV though.
If you have a nearly perfect credit score and credit history, then your lender might be willing to accept a higher LTV than normal. But the same goes for the reverse as well. If you have a really bad credit history, your loan will be considered a higher risk. So your mortgage lender might require an even lower LTV than normal to approve your loan.
How Does LTV Affect Your Monthly Mortgage Payments?
The loan-to-value ratio affects practically everything when it comes to your mortgage. From your monthly mortgage payments to the overall life of your loan.
The higher the deposit you pay for the home the lower the amount you will need to borrow from your mortgage lender. That means your LTV will also be lower.
So the lower your LTV the lower the amount that you need to repay thus the lower your monthly payments will be.
The problem with having a higher LTV is that it makes everything higher because you are a higher risk to your mortgage lender.
Because you are paying less of a down payment that usually means you will pay a higher interest rate. Not only that, but a smaller down payment also can mean that you need to get mortgage insurance.
If your lender is still wary of approving your loan, they might require you to also get mortgage insurance which is an additional payment that you will need to make monthly. And on top of all of that, your higher LTV amount will also mean your mortgage insurance will probably cost you more.
All in all, your loan-to-value ratio can change so much about your mortgage loan and should not be taken lightly. If you are looking for a home, remember to stay within your budget and make absolutely certain that you are financially ready for this type of purchase.