Loan-to-value ratio

Key Takeaways

• Loan to value ratio, written LTV, is the loan amount divided by the property's value and expressed as a percentage.
• On a purchase the lender uses the lower of the contract price or the appraised value as the denominator, so a low appraisal raises the LTV on the same loan.
• A higher LTV means less borrower equity and more lender risk, which usually shows up as mortgage insurance, a higher rate, or a smaller loan.
• Loan to value and down payment describe the same deal from opposite ends: a 20 percent down payment on a purchase produces an 80 percent LTV.

What It Means

The loan to value ratio, almost always written LTV, compares the size of a loan to the value of the property securing it. Divide the loan amount by the value and state the answer as a percentage. A $180,000 loan on a $200,000 house is a 90 percent LTV. The other 10 percent is the borrower's Equity, and that slice is the cushion standing between the lender and a loss.

Value here is not automatically the sale price. On a purchase the lender underwrites against the lower of the contract price or the Appraisal figure, so a house that appraises below the agreed price pushes the LTV up unless the buyer brings more cash. That one rule sits behind most of the financing renegotiations that happen after mutual acceptance.

LTV drives the terms a borrower is offered. On a conventional loan a down payment of less than 20 percent, which is an LTV above 80 percent, normally means Private Mortgage Insurance Pmi, and rate pricing gets worse as the ratio climbs. Government backed programs allow much higher ratios because a federal guarantee stands in for borrower equity.

How It Works in Washington

The ratio itself is national arithmetic, but the consequence of a thin equity cushion is set by state foreclosure law. In Washington, a home loan is normally secured by a Deed Of Trust, which RCW 61.24.020 describes as a deed conveying real property to a trustee in trust to secure the performance of an obligation, and the lender enforces it through a nonjudicial trustee's sale under RCW 61.24 rather than through a lawsuit.

That is why LTV carries real weight here. Under RCW 61.24.100 a deficiency judgment generally cannot be obtained against a borrower, grantor, or guarantor after a trustee's sale under the deed of trust. The lender's recovery is whatever the property brings at auction and nothing more, so the equity margin built in at origination is the lender's whole protection against a falling market. A 95 percent LTV loan leaves five points of cushion before the lender is underwater, which is exactly why higher ratio loans are priced higher, insured, or declined.

Example

Dana agrees to buy a house in Kent for $500,000 and applies for a $450,000 loan, expecting a 90 percent LTV and a $50,000 down payment.

The appraisal comes in at $480,000. The lender underwrites against the lower of price or appraised value, so the same $450,000 loan is now $450,000 divided by $480,000, which is 93.75 percent. That is above the program's 90 percent ceiling.

To get back to 90 percent the loan is capped at 90 percent of $480,000, which is $432,000. Dana can bring the $18,000 difference in cash, which raises her total cash to close from $50,000 to $68,000, since $500,000 minus $432,000 is $68,000. Her other moves are to renegotiate the price down toward $480,000, ask the lender for a reconsideration of value, or use her financing contingency to withdraw.

Common Mistakes and Exam Traps

• LTV uses the lower of sale price or appraised value, so a candidate who divides by the contract price on a low appraisal question will get the wrong ratio.
• Loan to value is not the debt to income ratio; LTV measures the loan against the property, while debt to income measures payments against the borrower's earnings.
• A higher LTV means less owner equity, not more; the ratio and the borrower's stake move in opposite directions.
• Combined loan to value adds every loan secured by the property, so a first at 80 percent plus a second at 10 percent is a 90 percent CLTV even though neither loan alone breaks the ceiling.