If you are planning on applying for a home loan or for a mortgage refinance, you are likely going to want to know your loan-to-value (LTV) ratio. This is calculated by dividing the loan principal by the value of the property. It’s an important metric when getting a mortgage approved because it reflects how much of the property’s value you are borrowing. A higher number may be seen as a riskier proposition by prospective lenders.
Here, you’ll learn the ins and outs of calculating LTV, why it matters, and how it can have a financial impact over the life of a loan.
LTV, a Pertinent Percentage
The relationship between the loan amount and the value of the asset securing that loan constitutes LTV.
To find the loan-to-value ratio, divide the loan amount (aka the loan principal) by the value of the property.
LTV = (Loan Value / Property Value) x 100
Here’s an example: Say you want to buy a $200,000 home. You have $20,000 set aside as a down payment and need to take out a $180,000 mortgage. So here’s what your LTV calculation looks like:
180,000 / 200,000 = 0.9 or 90%
Here’s another example: You want to refinance your mortgage (which means getting a new home loan, hopefully at a lower interest rate). Your home is valued at $350,000, and your mortgage balance is $220,000.
220,000 / 350,000 = 0.628 or 63%
As the LTV percentage increases, the risk to the lender increases.
Why Does LTV Matter?
Two major components of a mortgage loan can be affected by LTV: the interest rate and private mortgage insurance (PMI).
Interest Rate
LTV, in conjunction with your income, financial history, and credit score, is a major factor in determining how much a loan will cost.
When a lender writes a loan that is close to the value of the property, the perceived risk of default is higher because the borrower has little equity built up and therefore little to lose.
Should the property go into foreclosure, the lender may be unable to recoup the money it lent. Because of this, lenders prefer borrowers with lower LTVs and will often reward them with better interest rates.
Though a 20% down payment is not essential for loan approval, someone with an 80% LTV or lower is likely to get a more competitive rate than a similar borrower with a 90% LTV.
The same goes for a refinance or home equity line of credit: If you have 20% equity in your home, or at least 80% LTV, you’re more likely to get a better rate.
If you’ve ever run the numbers on mortgage loans, you know that a rate difference of 1% could amount to thousands of dollars paid in interest over the life of the loan.
Let’s look at an example, where two people are applying for loans on identical $300,000 properties.
Person One, Barb:
• Puts 20%, or $60,000, down, so their LTV is 80%. (240,000 / 300,000 = 80%)
• Gets approved for a 4.5% interest rate on a 30-year fixed-rate mortgage
• Will pay $197,778 in interest over the life of the loan
Person Two, Bill:
• Puts 10%, or $30,000, down, so their LTV is 90%. (270,000 / 300,000 = 90%)
• Gets approved for a 5.5% interest rate on a 30-year fixed-rate mortgage
• Will pay $281,891 in interest over the life of the loan
Bill will pay $84,113 more in interest than Barb, though it is true that Bill also has a larger loan and pays more in interest because of that.
So let’s compare apples to apples: Let’s assume that Bill is also putting $60,000 down and taking out a $240,000 loan, but that loan interest rate remains at 5.5%. Now, Bill pays $250,571 in interest;
The 1% difference in interest rates means Bill will pay nearly $53,000 more over the life of the loan than Barb will. (It’s worth noting that there are costs when you refinance a mortgage; it’s a new loan, with closing expenses.)
💡 Quick Tip: You deserve a more zen mortgage. SoFi Mortgage Loan Officers are dedicated to closing your loan on-time — backed by a $5,000 guarantee offer.‡
PMI or Private Mortgage Insurance
Your LTV ratio also determines whether you’ll be required to pay for private mortgage insurance, or PMI. PMI helps protect your lender in the event that your house is foreclosed on and the lender assumes a loss in the process.
Your lender will charge you for PMI until your LTV reaches 78% (by law, if payments are current) or 80% (by request).
PMI can be a substantial added cost, typically ranging anywhere from 0.1% to 2% of the value of the loan per year. Using our example from above, a $270,000 loan at 5.5% with a 1% PMI rate translates to $225 per month for PMI, or about $18,800 in PMI paid until 20% equity is reached.
Recommended: Understanding the Different Types of Mortgage Loans
How Does LTV Change?
LTV changes when either the value of the property or the value of the loan changes.
If you’re a homeowner, the value of your property fluctuates with evolving market pressures. If you thought the value of your property increased significantly since your last home appraisal, you could have another appraisal done to document this. You could also potentially increase your home value through remodels or additions.
The balance of your loan should decrease over time as you make monthly mortgage payments, and this will lower your LTV. If you made a large payment toward your mortgage, that would significantly lower your LTV.
Whether through an increase in your property value or by reducing the loan, decreasing your LTV provides you with at least two possible money-saving options: the removal of PMI and/or refinancing to a lower rate.
💡 Quick Tip: Generally, the lower your debt-to-income ratio, the better loan terms you’ll be offered. One way to improve your ratio is to increase your income (hello, side hustle!). Another way is to consolidate your debt and lower your monthly debt payments.
The Takeaway
The loan-to-value ratio affects two big components of a mortgage loan: the interest rate and private mortgage insurance. A lower LTV percentage typically translates into more borrower benefits and less money spent over the life of the loan.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
‡SoFi On-Time Close Guarantee: If all conditions of the Guarantee are met, and your loan does not close on or before the closing date on your purchase contract accepted by SoFi, and the delay is due to SoFi, SoFi will provide you $2,000.^ Terms and conditions apply. This Guarantee is available only for loan applications submitted after 6/15/22 for the purchase of a primary residence. Please discuss terms of this Guarantee with your loan officer. The property must be owner-occupied, single-family residence (no condos), and the loan amount must meet the Fannie Mae conventional guidelines. No bank-owned or short-sale transactions. To qualify for the Guarantee, you must: (1) Have employment income supported by W-2, (2) Receive written approval by SoFi for the loan and you lock the rate, (3) submit an executed purchase contract on an eligible property at least 30 days prior to the closing date in the purchase contract, (4) provide to SoFi (by upload) all required documentation within 24 hours of SoFi requesting your documentation and upload any follow-up required documents within 36 hours of the request, and (5) pay for and schedule an appraisal within 48 hours of the appraiser first contacting you by phone or email. The Guarantee will be void and not paid if any delays to closing are due to factors outside of SoFi control, including delays scheduling or completing the appraisal appointment, appraised value disputes, completing a property inspection, making repairs to the property by any party, addressing possible title defects, natural disasters, further negotiation of or changes to the purchase contract, changes to the loan terms, or changes in borrower’s eligibility for the loan (e.g., changes in credit profile or employment), or if property purchase does not occur. SoFi may change or terminate this offer at any time without notice to you. ^To redeem the Guarantee if conditions met, see documentation provided by loan officer.
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