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There are a lot of numbers involved in buying and owning a home, like your credit score or debt-to-income (DTI) ratio.
Another equally important number – not only when you buy your home, but throughout homeownership – is your loan-to-value (LTV) ratio.
Whether you’re looking to become a homeowner or already own a home, it’s helpful to understand what your LTV is, how to calculate it and the importance of LTV and to learn how to lower it if it’s too high.
What is Loan-To-Value Ratio?
LTV is a metric banks and lenders check to get a sense of how you handle debt, to determine if you’re a good risk and to consider you for a mortgage. It’s a proportion of the amount you owe in relation to the value of your home.
As you pay down your mortgage and your home value increases (hopefully), your LTV will change.
How To Calculate Your LTV
To calculate your home’s LTV, divide your loan amount by the current value of the home.
Let’s say you want to buy a home that’s valued at $200,000.
The LTV (your loan divided by the home’s value) will be based on how much you’re able to spend on your down payment.
The more you contribute to your down payment, the lower your LTV ratio will be.
|Down Payment||Amount Borrowed||LTV|
Now, let’s fast forward a few years.
You’ve been dutifully making payments on your mortgage and you’ve lowered your mortgage balance by $10,000. At the same time, the housing market has picked up and the value of your home has changed.
Here’s how your LTV might change based on your home’s value and mortgage balance:
|Current home value||Current Mortgage Balance||LTV|
And congrats! You’ve lowered your LTV. And that means you can access even more of the benefits that come with homeownership.
Why Your LTV Matters
Your LTV ratio is important because it’ll help determine what kind of loan and refinancing options you can qualify for and what your interest rate will be.
LTV and conventional loans: The cost of mortgage insurance
When you buy a home with a conventional mortgage (a mortgage that’s not backed by the federal government), a mortgage lender will typically require that a buyer make a down payment of 20% (which would make the LTV 80%).
If your LTV is more than 80%, the lender will require that you purchase private mortgage insurance (PMI).
PMI is a monthly fee that gets added to your mortgage payment. It doesn’t contribute toward your mortgage principal or interest, and you’ll continue to pay the fee until your LTV hits 78% or you refinance to a lower LTV.
LTV and FHA loans: The cost and life of mortgage insurance premiums
Federal Housing Administration (FHA) loans have lots of benefits. You can qualify with a lower credit score and qualify with an LTV as high as 96.5%. They’re a great option for first-time home buyers and home buyers with past credit issues.
One drawback of FHA loans is that you have to pay mortgage insurance premiums (MIPs). The premium is a fee you pay to help insure a loan that would typically be considered a higher-risk loan.
With FHA loans, you pay an upfront mortgage insurance premium (UFMIP) of 1.75% at closing, and then you pay an annual premium (divided into 12 monthly installments) for 11 years or the life of the loan.
The size of your monthly premium and the amount of time you pay it will depend on … you guessed it: your LTV.
Let’s say you’ve got a $200,000 FHA loan with a 30-year mortgage term.
If you put:
- 10% or more down, you’d have an LTV of 90% or lower
- 5% – 9% down would give you an LTV of 91% – 95%
- Less than 5% down would give you an LTV of more than 95%.
Check out how LTV would affect how much you’d pay in MIP and for how long you’d pay for it.
(% of loan value)
|Annual Cost||Duration||Total Cost|
|90% or lower||0.8%||$1,600||11 years||$17,600|
|91% – 95%||0.8%||$1,600||Life of loan||$48,000|
|More than 95%||0.85%||$1,700||Life of loan||$51,000|
LTV and VA loans: The cost of upfront funding fees
If you qualify for a Department of Veterans Affairs (VA) loan, your LTV will affect how much you pay for the home.
VA loans don’t require mortgage insurance, but you are required to pay an upfront funding fee at closing. The fee – which is a percentage of the current value of your home – is determined by your LTV.
|If your LTV is …||Funding Fee (% of loan value)|
|90% or lower||1.4%|
|91% – 95%||1.65%|
|More than 95%||2.3% the first time (3.6% for each loan used afterward)|
LTV and refinancing: The ongoing cost of PMI
Let’s say you want to refinance your mortgage.
The most common reasons to refinance are:
- Lowered interest rates
- Lowered monthly payments
- Shortened mortgage payment term
Another big reason to refinance? Getting rid of – or reducing – your mortgage insurance. To do that, you’ll want to wait until you have an LTV of 80% – 85%. Otherwise, you’ll be stuck paying mortgage insurance for a little longer.
LTV and home equity loans: The combined loan-to-value (CLTV) effect
A home equity loan (commonly referred to as a second mortgage) or home equity line of credit (HELOC) can help you “withdraw” money from your home and use it to make home improvements and repairs or pay down higher interest debt.
Home equity loans and HELOCs both offer lower interest rates compared to personal loans and credit cards. And both of these loans will be based on your combined loan-to-value (CLTV) ratio.
Your CLTV is the combined amount of your current (or primary) mortgage balance plus the amount of the HELOC or home equity loan you’re getting divided by the current value of the home. In other words, your CLTV is the total of all the liens on your home and helps lenders assess risk when deciding whether to approve your home equity, HELOC or refinance application.
If your LTV is 80% or more, that won’t leave a lot of room for you to meet the CLTV requirement, especially when you add in closing costs between 2% and 5% on a home equity loan.
That’s why knowing your LTV matters. Otherwise, borrowing against your home equity may not be an option, or it may cost you more than it’s worth.
How To Lower Your LTV
Now that you know more about how your LTV works and why it’s important, let’s look at how you can improve your LTV if you have a higher LTV ratio.
Make a larger down payment
There are lots of reasons why making a smaller down payment might be the right financial decision for you. But, if you have the money available (and it won’t wreck your budget), consider making a larger down payment. It would reduce the amount of money you would need to borrow from your lender, and, as a result, it would lower your LTV.
And here’s another bonus: With a smaller loan, you’d pay less in interest throughout the life of the loan, which would help you save a ton of money in the long run.
Look for down payment assistance
If you have family members (including extended family, adopted family, a fiancé(e) or a domestic partner) who can help you make a down payment, it doesn’t hurt to ask for help. The IRS sets the rules on how much you can receive as a gift before the donor has to pay gift tax, but you may be surprised at how flexible many of the rules around gifting are.
If you’re getting an FHA loan, you may qualify for down payment assistance from your employer, a labor union, a charitable organization or a state or community organization that helps first-time home buyers with down payment assistance.
Buy a less expensive home
You may know what your dream home looks like, but can you afford it? If your dream house is out of reach right now, consider looking for a more affordable option. It may make money sense to buy a home that lets you make a larger down payment and lowers your LTV.
Bonus: If you want to add on to your home later, your lower LTV will make it easier to refinance or get a home equity loan in the future.
Make your monthly payments + extra
The easiest way to lower your LTV is to make your mortgage payments on time and in full every month. If you want to speed the process up, try paying a little extra each month. Every extra dollar goes directly toward paying down your mortgage balance.
Even an extra $100 a month can lower your LTV faster and shave years off your mortgage repayment schedule. That can save you a lot in interest over the life of your mortgage.
Reappraise your home
One of the best parts of investing in a home is that its value tends to go up over time. Keep an eye on the housing prices in your area. If home values are going up, you may want to consider getting your home reappraised.
When you get your home reappraised, a professional appraiser may inspect key elements of your home and property and compare your home with similar homes in your area. They’ll use those metrics to estimate the fair market value of your home.
If the appraised value of your home has increased by enough, you may be able to refinance your home with an improved LTV. That means you can say goodbye to your mortgage insurance and maybe even get a lower interest rate.
The Power of Knowing Your LTV
Knowing your LTV can help you to make smart decisions about the real costs of buying a home and help you decide how much home you can afford and what type of mortgage is best for you.
Knowing your LTV can also help you weigh whether a refinance or home equity loan is the best choice.
So, break out your calculator and your mortgage statements, assess the value of your home and find out what your LTV is today.
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U.S. Department of Housing and Urban Development. “APPENDIX 1.0 – MORTGAGE INSURANCE PREMIUMS.” Retrieved September 2021 from https://www.hud.gov/sites/documents/15-01MLATCH.PDF
U.S. Department of Veterans Affairs. “VA funding fee and loan closing costs.” Retrieved September 2021 from https://www.va.gov/housing-assistance/home-loans/funding-fee-and-closing-costs/